In the butterfly, you use three strikes; a variation of the short call butterfly is the short call condor. Instead of one middle range strike price, this volatility strategy has two.
In the short call condor, you combine one in-the-money short call with one in-the-money long call; and one out of the money long call and one out of the money short call. The position is neutral, meaning your profit potential is the same no matter which direction the underlying price moves.
Example: The underlying stock is trading at approximately $36.50 per share. You expect the price to either rise or fall substantially. A rumor is out that the company may be acquired. If true, the offer is expected to be far higher than current price; if it falls through, you believe the stock price will tumble many points. This is a perfect situation for the short call condor. Volatility in either direction will create profits.
You set up the position by selling one 30 strike call at 7 and buying one 35 strike at 3.50; you also buy one 40 strike at 1 and sell one 45 strike at 0.50. Your net credit (before transaction costs) is $300. All of these calls expire on the same date three months away. The outcome at various prices demonstrates that with movement of the stock in either direction, profits are going to be realized. The maximum profit is $300 if the stock price ends up at $30 or lower or at $50 or higher by expiration:
Value at expiration
Stock short long long short
Price 30 35 40 45 total
20 700 – 350 – 100 50 300
25 700 – 350 – 100 50 300
30 700 – 350 – 100 50 300
35 200 – 350 – 100 50 – 200
40 – 300 150 0 50 – 100
45 – 800 650 400 0 250
50 -1,300 1,150 900 – 450 300
55 -1,800 1,650 1,400 – 950 300
As long as the stock price remains within the middle zone, losses are minor. The advantage to this strategy is that you collect premium for opening the combined short and long, and you can close the short calls at any time. As long as volatility is high, you will profit whether the stock moves up or down. The disadvantage is that returns are small compared to some other straddle positions, but risk in those alternatives is likely to be greater as well.
All complex option strategies have to be judged based on their overall merit, limited risk and exposure to loss. In addition, a broker will require margin maintenance for positions like the short call condor, which ties up capital until either expiration occurs or then position (or the short portions of it) are closed. The elegance of limited profits in exchange for limited losses has to be judged with these factors in the balance.
In the virtual portfolio I manage at ThomsettOptions.com I experiment with options trades in a virtual portfolio. I’ve done dozens of other strategies and when I set up new trades, I usually include a stock chart with detailed analysis of why the trade makes sense. Please join me at http://tinyurl.com/aqeeops to see how these trades work out, and to get many more useful articles. You can also subscribe to our FREE weekly newsletter just by signing up.