Market Overview

The Short Call Condor

The short call is an intriguing position to open, if only because so many traders see it as way too risky to even consider. But some strategies are perfectly suited to take advantage of two great short call features: offset of risk, and premium receipt.

 One variation is the short call butterfly, which employs three strikes. An expansion of this which adds even greater variability is the short call condor. This expands the butterfly by adding another mid-range strike. Thus, there are four strikes overall, with the short side on the highest and lowest side and the long positions in the two middle strikes.

Properly set up, this strategy is neutral and the net profit/loss requires movement in either direction. The more movement experienced, the better the outcome. The ideal placement of the underlying price should be halfway between the two long calls, right in the middle of the position. This sets up a short call condor with a short OTM call, a long OTM call, a long ITM call and a short ITM call.

For example, Netflix (NASDAQ: NFLX) was at $81.25 on the morning of April 30, 2012. You could set up a short call condor using four strikes as follows:

  • Short June 77.50: - 9.80
  • Long June 80: 6.80
  • Long June 82.50: 5.50
  • Short June 85: - 4.53
  • Net credit: - 2.03

The net credit makes this overall position desirable, as far as it goes; you receive funds rather than paying. If the stock price remains within the middle zone, a loss will occur; however, it is fixed. The farther away from this the price moves in either direction, the higher the profit potential.

However, the great disadvantage is that with even with high volatility, returns are going to be small, even smaller than the profits possible with other strategies including the most more simple synthetic long or short stock, the basic butterfly, or the collar.

On a practical level, the likely outcome of this strategy will be to close one or both of the high/low short positions, while leaving the long positions with the change to gain in value. Closing the shorts reduces risk but also reverts the original credit to a likely debit. However, if timed well, the net overall cost of closing short positions could result in relatively cheap remaining long calls.

So compared to the very difficult strategy of opening a long spread, the net cost of the revised short call condor may be the end result and desirable outcome.

All option strategies have to be judged based on overall value versus overall risk, and this is no exception. For many traders, the time until expiration is a major factor in consideration for two reasons.

First, options have the highest rate of time decay during the last two months, so focusing on positions within that range will be most likely to create fast profits in the short calls. Second, margin requirements could be too high to make this strategy practical. When considering the margin requirements against profit potential, the size of margin might simply be too great to justify the position.

Thus, even if it looks good on paper, the practical limitations curtail the effectiveness of the short call condor.

 The final decision to open a short call condor properly rests with the evaluation of volatility. By maximizing timing, you also maximize the net credit you will pay, while minimizing the mid-range risk at the same time. The key to mastering this, as with other complex strategies, is timing for implied volatility ("IV"). This is where skill comes into the picture.

Even the best strategy works well only if timed properly; and IV is the key. A volatility-based strategy can be complex without help, but it can be simple and easy with the right tracking tools. To improve your option trade timing, check the Benzinga service Options & Volatility Edge which is designed to help you improve selection of options as well as timing of your trades.

Posted-In: butterfly condor collar implied volatility margin requirementsShort Ideas Options Markets Trading Ideas Best of Benzinga

 

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