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Short Condor Spreads: Finding Good Candidates

Short Condor Spreads: Finding Good Candidates

Key Points
  • Short condor spreads are a breakout strategy generally used when you expect a relatively high priced underlying stock (or ETF) to move sharply in price either in an upward or a downward direction.

  • When selecting short condor candidates, consider underlying securities that are trading near a price that falls about midway between two standard options strike prices, but have had a recent history of big moves both up and down.  

  • We will review how to set up and enter a short condor spread order as well as evaluate gain/loss scenarios. 

A short condor spread is a four-legged options strategy with four different strike prices established with the same contract quantity for each leg. A short condor can be built with either calls or puts (but not a combination of both). Each option should have the same expiration date.

Additionally, the intervals between the upper two strikes and lower two strikes ("wing widths") must be equal in order for the legs to be paired as a condor strategy by Schwab. The interval between the middle strikes ("body width") may differ.

Here’s an example of a short condor strategy with calls:

Sell 5 XYZ Dec 300 calls @ 24.90
Buy 5 XYZ Dec 315 calls @ 16.30
Buy 5 XYZ Dec 330 calls @ 9.00
Sell 5 XYZ Dec 345 calls @ 4.10

Short condor spreads are a breakout strategy generally used when you expect a relatively high priced underlying stock (or ETF) to move sharply in price either in an upward or a downward direction.

How does it differ from a short butterfly spread?

Like a short butterfly, a short condor is a strategy used when you expect the underlying stock (or ETF) to move sharply higher or lower, but you are unsure which way the stock will move.

A trader might select a short condor instead of a short butterfly, even though it typically has a larger zone over which losses can be incurred, because it typically brings in a larger credit and therefore has a higher maximum profit than a comparable short butterfly.

How does it differ from a long strangle?

If you are familiar with long strangles, which involve buying a call option and put option of the same underlying security and the same expiration date but with different strike prices, you can think of short condors as taking a slightly more conservative approach to any stock you might consider as a long strangle candidate.

Short condors differ from long strangles in that you collect a credit when the positions are established, rather than paying a debit. With the premium received from writing the short legs, the maximum loss for the short condor strategy is typically smaller than the maximum loss for a comparable long strangle (depending on strike price selections and premium amount)—but the maximum gain is smaller too. We'll discuss the maximum gain and loss in more detail in "How to calculate price levels" below.

Selecting stock candidates

Your best chance for a profitable short condor spread will come from an underlying stock that breaks out sharply higher or lower in price. You might look at a stock that is typically volatile but has been less volatile than normal recently. 

Stocks that fit this pattern typically consolidate around a point of support or resistance and then the price will either turn back away, or break through that point. If this breakthrough happens, this strategy should benefit both from the stock price movement and a potential increase in volatility.

Another possible breakout candidate might be a stock that is simply always volatile and regularly makes sharp swings in either direction—as long as you don’t expect a drop in volatility.

Look for stocks that may have most of the following criteria:

  • Sharp price movements: They are expected to move sharply higher or lower than the current price.
  • Increasing volatility: They have lower than normal volatility, but you expect their volatility could increase in the near future.
  • Continued volatility: They may be very volatile and are expected to continue that way.
  • Trading near the midpoint between two standard option strike prices: They are currently trading at a price that is about midway between two standard option strike prices, such as 100, 120, 150, 200, 220, etc.
  • Trading above $100 per share: You'll typically need to focus on stocks with prices above $100 per share to find enough candidates because profitability on a short condor often requires a larger price movement, when compared to the use of a short butterfly, which may be more appropriate for lower priced stocks.
  • Long strangle possibilities: They are also a good long strangle candidate.

While these criteria might sound overly restrictive, you may be surprised how many candidates you may find with only a little research. Then, it is often helpful to draw the important price levels on a price chart, such as those available in StreetSmart Edge®. This will help you visualize stock price movements that may result in a profitable or unprofitable strategy.

How to calculate price levels

First, let's take a look at how to calculate the key price levels on a sample 10-point short put condor. Assuming stock XYZ is trading at $189.51, the following formulas will allow you to calculate the maximum gain, maximum loss, and upper and lower breakeven prices at the options expiration date on any short condor spread.

Note: To simplify the calculations, commissions have been excluded from the examples in this article. 

Example of a 10-point short condor spread:

Sell to open 10 XYZ Dec 175 Puts @ 2.49 bid
Buy to open 10 XYZ Dec 185 Puts @ 5.60 ask
Buy to open 10 XYZ Dec 195 Puts @ 10.95 ask
Sell to open 10 XYZ Dec 205 Puts @ 16.75 bid

Net credit = 2.69 per contract (+2.49 - 5.60 - 10.95 + 16.75)
Maximum gain = 2.69 per contract (credit received; occurs beyond the outside strike prices) or $2,690 (2.69 x 10 contracts x 100 multiplier)
Maximum loss = 7.31 per contract (10-point "wing width" - 2.69 credit per contract; occurs between the middle strike prices) or $7,310 (7.31 x 10 contracts x 100 multiplier)
Upper breakeven = $202.31 (upper middle strike 195 + maximum loss per contract 7.31) 
Lower breakeven = $177.69 (lower middle strike 185 – maximum loss per contract 7.31)

Or, StreetSmart Edge can calculate these amounts for you as shown below.

Calculating maximum gain, maximum loss and breakeven for a short condor spread at expiration

Calculating maximum gain, maximum loss and breakeven for a short condor spread at expiration

Source: StreetSmartEdge.

Creating charts

To visualize this short condor spread on a chart, you'll want to include lines that represent the outside strike prices of $175 and $205 (maximum gain levels) and the upper and lower breakeven levels of $202.31 and $177.69. A convenient way to do this is to use the support and resistance lines, which are typically used for technical analysis, to illustrate the breakeven and maximum loss levels. Use the resistance line tool to draw red lines for the inner breakeven lines, and the support line tool to draw green lines for the outer maximum gain levels as illustrated below.

Breakeven and maximum gain thresholds at expiration

Breakeven and maximum gain thresholds at expiration

Source: StreetSmart Edge.

This chart was taken on November 3, 2014, with the December short put condor having about 47 days until expiration, with XYZ trading at a price of $189.51. It illustrates that if XYZ is between $177.69 and $202.31 at the December option expiration, this short condor spread will be unprofitable. The maximum loss will be reached if XYZ is anywhere from $185 to $195 at expiration.

This short condor spread will be profitable if XYZ closes above $202.31 at expiration, with the maximum profit of $2,690 occurring at any price above $205. Likewise, the short condor spread will also be profitable if XYZ closes below $177.69 at expiration, with the maximum profit of $2,690 also occurring at any price below $175.

Unlike with short butterfly spreads, it is quite likely that a short condor spread can expire in the maximum loss zone since this can occur over a range of prices (this example covers a 10-point maximum loss range from $185 to $195). In this example, XYZ has to move up more than 12.80 points ($202.31 - $189.51), or down more than 11.82 points ($189.51 - $177.69) to end up profitable at expiration.

Condor candidates with other profit and loss features

Let’s review one more example to illustrate a 15-point short call condor candidate, with different profit and loss levels. Assuming stock XYZ is trading at $320.98, the following formulas will allow you to calculate the maximum gain, maximum loss, and upper and lower breakeven prices at the options expiration date on any short condor spread. 

Example of a 15-point short condor spread:

Sell to open 5 XYZ Dec 300 Calls @ 25.60 bid
Buy to open 5 XYZ Dec 315 Calls @ 16.50 ask
Buy to open 5 XYZ Dec 330 Calls @ 9.20 ask
Sell to open 5 XYZ Dec 345 Calls @ 4.10 bid

Net credit = 4.00 per contract (+25.60 – 16.50 – 9.20 + 4.10)
Maximum gain = 4.00 per contract (credit received; occurs beyond the outside strike prices) or $2,000 (4.00 x 5 contracts x 100 multiplier)
Maximum loss = 11.00 per contract (15-point "wing width" - 4.00 credit per contract; occurs between the middle strike prices) or $5,500 (11.00 x 5 contracts x 100 multiplier)
Upper breakeven = $341 (upper middle strike 330 + maximum loss 11.00)
Lower breakeven = $304 (lower middle strike 315 – maximum loss 11.00)

Or, StreetSmart Edge can calculate these amounts for you as shown below.

Calculating maximum gain, maximum loss and breakeven for a short condor spread at expiration

Calculating maximum gain, maximum loss and breakeven for a short condor spread at expiration

Source: StreetSmart Edge.

The lines you’ll want to show on the chart are the outside strike prices of $300 and $345 (the maximum gain levels, represented by the green lines) and the upper and lower breakeven levels of $341 and $304 (represented by the red lines). Using the support and resistance line tool creates a chart as illustrated below:

Breakeven and maximum gain thresholds at expiration

Breakeven and maximum gain thresholds at expiration

Source: StreetSmart Edge.

This chart was taken on November 4, 2014 as the December short condor had about 46 days until expiration, with XYZ trading at a price of $320.98. If XYZ is between $304 and $341 at the December option expiration, this short condor spread will be unprofitable. The maximum loss will be reached if XYZ is anywhere from $315 to $330 at expiration.

This short condor spread will be profitable if XYZ closes above $341 or below $304 at expiration, with the maximum profit of $2,000 occurring at any price above $345 or below $300.

Unlike with short butterfly spreads, it is quite likely that a short condor spread can close in the maximum loss range since this can occur over a range of prices (this example covers a 15-point maximum loss range from $315 to $330). In this example XYZ has to move up more than 20.02 points ($341 – $320.98), or down more than 16.98 points ($320.98 – $304) to end up profitable at expiration.

Keep in mind

Both of these examples require a fairly substantial move by the underlying security in order to reach profitability. Many option traders prefer short condors to long strangles because the premiums received from the legs allow them to be entered at a net credit, rather than at a net debit.

I hope this enhanced your understanding of how to research and evaluate short condor spread candidates. I welcome your feedback—clicking on the thumbs up or thumbs down icons at the bottom of the page will allow you to contribute your thoughts. (If you are logged into Schwab.com, you can include comments in the Editor’s Feedback box.)

Next Steps

Talk to Us

To discuss how this article might affect your investment decisions:

-          Call Schwab anytime at 800-435-9050.
-          Talk to a Schwab Financial Consultant at your local branch.

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