The long condor is quite similar to the long butterfly, except that an extra strike price is used in the middle to widen the range in which the trade makes money.
In our example, ABC is trading at $55 and we will focus on options with 3 months until expiration. Below is a list of strikes and prices for these back-month options.
The condor starts out the same way as the butterfly, buying 1 call with a 50 strike. But instead of selling 2 of the 55 strikes, we sell only 1 of the 55 calls and then we sell 1 of the 60 calls as well. (In the butterfly, we were buyers of the 60 strike). Since this leaves us net short one call on the upside, which we don't want for an indefinite range, we must protect ourselves by buying 1 call with a 65 strike.
The condor involves buying a call spread and then selling another call spread with higher strikes than the one bought. As such, it must involve a net outlay, since the call spread purchased will always cost more than the one sold. Again, you can see in the table above that the difference between call prices declines as the strike prices rise. You are selling a spread with higher strike prices with the condor compared to the butterfly, so you are getting less for what you sell. Meanwhile, you are buying the same spread in these examples with both trades. Thus, the long condor costs more than the butterfly.
What does this trade cost? We'll have to pay a total of 7.10 for the wings, while we collect 4.50 for the middle strikes. So our net outlay, which also represents the most we can lose (our capital at risk, in other words), is 2.60.
The winning outcome should bear a strong resemblance to the butterfly. The difference, as you might expect, is that the best-case scenario happens over a range of prices instead of a single point. The range in this example is between 55 and 60.
At 55, the only option in the trade with value is the 50 call that we are long. It's worth 5 points, of course. As soon as the stock goes above 55, the call we wrote at 55 will offset any further gains from our 50 call, so the position will continue to be worth 5 points until we get to 60. At this point, the second call we wrote kicks in, kicks us, and keeps kicking us until the portfolio becomes worthless at 65. We cannot lose beyond this point by virtue of our 65 call.
So our best outcome is 5, for a 2.40 profit and a maximum 92% return on the 2.60 we risked. The upside of the condor is much lower than of the butterfly, but the chances of achieving it are far better. As with the butterfly, we lose all the capital risked on the trade below the bottom wing and above the top wing, or $2.60 in this case.
You can use puts just as easily as calls with the condor, or you can use a combination. One popular variation - the "iron condor" - involves a put credit spread at the lower 2 strikes and a call credit spread at the upper strikes. Because these credit spreads, by definition, involve up-front inflows, some investors prefer them to more traditional condor trades, even though the ultimate economics are essentially the same.
Short Condor
In the discussion about the long condor, we noted that because the strategy is profitable at a much wider range of stock prices than the butterfly, the opportunity for large profits and returns on capital is necessarily much lower. Consequently, the short condor allows someone who expects volatility to pick up to express this opinion and, if correct, get a significantly better return than the seller of a butterfly.
In other words, by accepting that you will take moderate losses if the stock or index stays in a certain range, you will be paid with returns of 100% or greater while having a good likelihood of recouping some capital even if you are wrong.
A major problem with the short condor's cousin, the short butterfly, is that you get a payoff profile more typically associated with being short volatility (you can lose a lot more than you can win) but you need high volatility (a generally low-probability state of affairs) for your best outcome. The short condor puts the payoff numbers more in your favor, at the cost of less frequent winning trades. Returning to the numbers of our previous example:
With the short condor (as with the short butterfly), the best outcome is for the underlying stock to close below the lowest strike or above the highest strike. Since it's simply the other side of the long condor, referring back to the long condor example, the condor writer (person putting on the short condor trade) would buy the 55 call and sell the 50 call, as well as buy the 60 call and sell the 65 call. As a result, you would take in 2.60 up front before commissions and would keep all the premium in either of the outcomes just mentioned. This would come from the difference between the 50-55 call spread sold (3.50) and the 60-65 call spread bought (0.90).
The worst outcome is between 55 and 60, where the spread sold is at its maximum value of 5, while the purchased spread is worthless. Thus, the positions originally put on for a 2.60 credit will cost 5 to unwind (plus slippage and commissions).
Because no options would be exercised if the stock closed below the lowest strike, this is actually the most preferred outcome.
