Butterflies, Condors and Risk Limiting Strategies December 17, 2013 Joe Burgoyne, OIC www.optionseducation.org 2 The Options Industry Council Options involve risks and are not suitable for everyone. Prior to buying or selling options, an investor must receive a copy of Characteristics and Risks of Standardized Options. Individuals should not enter into options transactions until they have read and understood the risk disclosure document, Characteristics and Risks of Standardized Options, available by calling 1-888-OPTIONS or by visiting OptionsEducation.org. Copies may be obtained by contacting your broker or The Options Industry Council at One North Wacker Drive, Chicago, IL 60606. In order to simplify the computations, commissions, fees, margin interest and taxes have not been included in the examples used in these materials. These costs will impact the outcome of all stock and options transactions and must be considered prior to entering into any transactions. Investors should consult their tax advisor about any potential tax consequences. Any strategies discussed, including examples using actual securities and price data, are strictly for illustrative and educational purposes only and are not to be construed as an endorsement, recommendation, or solicitation to buy or sell securities. Past performance is not a guarantee of future results.
3 OIC s Participant Exchanges 4 Annual Options Volume, 1973-2012 Cleared Contracts
5 Slide Presentation Spread Basics Butterfly Spreads call butterfly iron butterfly Condor Spreads call condor iron condor Spread Basics
7 Spread Basics Spread is a position with both long and short options same underlying stock or ETF all calls, all puts, or both calls and puts Long and short sides of spread are called legs opening transactions limits (hedges) risk of the other(s) to some degree Spreads can be bullish, bearish or neutral depends on construction, not whether calls or puts 8 Spread Basics Spreads established at net debit or net credit differential between leg prices Debit spread long leg(s) cost more than received for short investor paying net debit is long the spread Credit spread more received for short leg(s) than paid for long investor receiving net credit is short the spread
9 Spread Basics Focus on leg price differential for pricing spread and/or trading in or out after established to track profit or loss Investor may trade in or out with spread order buy/sell legs simultaneously as a unit at net debit or net credit orders away from market may be disseminated but regarded as not held 10 Spread Basics Spreads can offer investors unique tradeoffs limited loss potential limited profit potential varying degrees depends on spread construction For a given market forecast, spreads may offer more acceptable risk versus reward ratios higher percentage profits versus outright purchase or sale of calls or puts
11 Spread Basics Time decay and rising/falling implied volatility? some spreads can protect you other spreads may take advantage of decay and volatility Trading spreads may involve firm-specific requirements accounts approved at higher levels minimum equity amounts 12 Vertical Spreads are Building Blocks Lower Strike Higher Strike Lower Strike Higher Strike Bull Vertical Spreads Bear Vertical Spreads
13 Vertical Spread Basics Vertical spread buy one option = long leg sell another option = short leg both calls or both puts different strike prices same expiration month same underlying stock always 1:1 ratio (long : short) net debit or net credit 14 Vertical Spread Basics Vertical spread characteristics limited loss potential limited profit potential reduced sensitivity to underlying price changes break-even point between strike prices Maximum spread value at expiration difference in strike prices (differential) x $100 both options in-the-money Minimum spread value at expiration zero (both options out-of-the-money and with no value)
15 Four Basic Vertical Spreads Bull call spread moderately bullish debit spread long call spread Bear put spread moderately bearish debit spread long put spread Bear call spread moderately bearish credit spread short call spread Bull put spread moderately bullish credit spread short put spread 16 Debit Spread Characteristics Bull Call Spreads and Bear Put Spreads Maximum loss limited to net debit paid for spread Maximum profit potential difference between strike prices net debit paid Margin net debit must be paid in full
17 Debit Spread Bull Call Spread Buy Lower Strike Call Sell Higher Strike Call Establish buy call with given strike sell call with higher strike same expiration month same underlying stock Bull Call Spread Always debit spread price of lower-strike call always greater than price of higher-strike call 18 Bull Call Spread Example Stock XYZ at $50.00 Spread: buy 1 XYZ 50.00 call $2.90 $1.70 net debit sell 1 XYZ 55.00 call + $1.20 Position: long 1 XYZ 50.00 call and short 1 XYZ 55.00 call long XYZ 50.00-55.00 call spread net debit = $1.70 or $170.00 total
19 Bull Call Spread at Expiration Buy 1 XYZ 50.00 call at $2.90 Sell 1 XYZ 55.00 call at $1.20 $1.70 net debit XYZ Price Long 50.00 Call Profit/(Loss) Short 55.00 Call Profit/(Loss) Combined Profit/(Loss) $60.00 $55.00 $51.70 $7.10 $2.10 ($1.20) ($3.80) $1.20 $1.20 $3.30 $3.30 0 $50.00 ($2.90) $1.20 ($1.70) $45.00 ($2.90) $1.20 ($1.70) 20 Credit Spread Characteristics Bear Call Spreads and Bull Put Spreads Maximum loss difference between strike prices net credit received Maximum profit potential limited to net credit received for spread Margin margin is required may be more than net credit received for spread
21 Credit Spread Bear Call Spread Sell Lower Strike Call Bear Call Spread Buy Higher Strike Call Establish buy call with given strike sell call with lower strike same expiration month same underlying stock Always credit spread price of higher-strike call always less than price of lower-strike call 22 Bear Call Spread Example Stock XYZ at $73.00 Spread: sell 1 XYZ 65.00 call + $9.40 $6.00 net credit buy 1 XYZ 75.00 call $3.40 Position: short 1 XYZ 65.00 call and long 1 XYZ 75.00 call short XYZ 65.00-75.00 call spread net credit = $6.00 or $600.00 total
23 Bear Call Spread at Expiration Sell 1 XYZ 65.00 call at $9.40 Buy 1 XYZ 75.00 call at $3.40 $6.00 net credit XYZ Price Long 75.00 Call Profit/(Loss) Short 65.00 Call Profit/(Loss) Combined Profit/(Loss) $80.00 $75.00 $71.00 $1.60 ($3.40) ($3.40) ($5.60) ($0.60) $3.40 ($4.00) ($4.00) 0 $70.00 ($3.40) $4.40 $1.00 $65.00 ($3.40) $9.40 $6.00 $60.00 ($3.40) $9.40 $6.00 24 Time Decay and Volatility For All Vertical Spreads Bull or Bear Debit or Credit Effect of time decay depends on stock price versus strikes between strikes effect generally minimal closer to long strike losses should increase at faster rate as time passes closer to short strike profits should increase at faster rate as time passes Effect of changing volatility depends on whether one or both legs are in-the-money amount of time until expiration
25 Four Basic Vertical Spreads Long Strike Long Strike Short Strike Short Strike Bull Call Spread Debit Bear Call Spread Credit Long Strike Short Strike Short Strike Long Strike Bull Put Spread Credit Bear Put Spread Debit Vertical spreads are building blocks for more advanced strategies Butterfly Spreads
27 Long Butterfly Basics Long butterfly spread to establish buy 1 option with lowest strike sell 2 options with middle strike buy 1 option with highest strike All calls or all puts same underlying stock same expiration month same strike price increment always 1:2:1 ratio (long to short to long) 3 option series Always net debit 28 Long Butterfly Basics Investor s position long 1 lowest strike wing short 2 middle strike body long 1 highest strike wing Investor is long butterfly has purchased butterfly for net debit Composition = two vertical spreads 1 bull spread and 1 bear spread 1 debit spread and 1 credit spread Profit potential and loss potential both limited
29 Long Butterfly Basics Neutral strategy Expectations for underlying trade in a range before expiration stabilize around middle (short) strike at expiration Motivations profit from time decay profit from decreasing implied volatility Investor wants to profit from stable underlying market unwilling to accept risk of short straddle 30 Long Butterfly at Expiration Maximum profit limited strike difference net debit paid for spread if underlying closes at middle (short) strike Maximum loss limited net debit paid for spread if underlying at or below lowest strike if underlying at or above highest strike Break-even points downside lowest strike + net debit paid upside highest strike net debit paid
31 Long Butterfly at Expiration Maximum Profit Maximum Loss Lowest Strike Downside BEP Middle Strike Highest Strike Upside BEP 32 Long Butterfly Basics Criteria for underlying selection sufficient liquidity Possible requirements for trading butterfly spreads accounts approved at higher levels minimum equity amounts firm-specific Margin net debit paid for in full greater initial margin amount possible firm-specific
Long Call Butterfly 34 Long Call Butterfly Long call butterfly to establish buy 1 call with lowest strike sell 2 calls with middle strike buy 1 call with highest strike Composition = 2 call vertical spreads bull call spread (debit) bear call spread (credit)
35 Long Call Butterfly Long Call Long Call Short Call Short Call Bull Call Short 2 Calls Bear Call Long 1 Call Long 1 Call Long Call Butterfly 36 Long Call Butterfly Example Stock XYZ currently at $61.00 Spread: Buy 1 XYZ 60.00 call $4.10 Sell 2 XYZ 65.00 calls + $2.00 Buy 1 XYZ 70.00 call $0.85 net cost: $0.95 debit XYZ 60.00-65.00-70.00 call butterfly purchased for $0.95 or $95.00 total Available 60-day calls XYZ 55.00 call $7.30 XYZ 60.00 call $4.10 XYZ 65.00 call $2.00 XYZ 70.00 call $0.85 XYZ 75.00 call $0.30
37 Long Call Butterfly Example Buy 1 XYZ 60.00 call at $4.10 Sell 2 XYZ 65.00 calls at $2.00 Buy 1 XYZ 70.00 call at $0.85 $0.95 net debit Downside break-even point lowest strike + net debit paid $60.00 + $0.95 = $60.95 Upside break-even point highest strike net debit paid $70.00 $0.95 = $69.05 38 Long Call Butterfly Example Buy 1 XYZ 60.00 call at $4.10 Sell 2 XYZ 65.00 calls at $2.00 Buy 1 XYZ 70.00 call at $0.85 $0.95 net debit Maximum profit strike difference net debit paid $5.00 $0.95 = $4.05, or $405.00 total Maximum loss net debit paid $0.95, or $95.00 total
39 Long Call Butterfly Example Buy 1 XYZ 60.00 call at $4.10 Sell 2 XYZ 65.00 calls at $2.00 Buy 1 XYZ 70.00 call at $0.85 $0.95 net debit XYZ Price Long 1 60.00 Call Profit/(Loss) Short 2 65.00 Calls Profit/(Loss) Long 1 70.00 Call Profit/(Loss) $70.00 $69.05 $67.00 $5.90 $4.95 $2.90 ($6.00) ($4.10) 0 ($0.85) ($0.85) ($0.85) $65.00 $0.90 $4.00 ($0.85) $63.00 ($1.10) $4.00 ($0.85) $60.95 ($3.15) $4.00 ($0.85) $60.00 ($4.10) $4.00 ($0.85) Combined Profit/(Loss) ($0.95) 0 $2.05 $4.05 $2.05 0 ($0.95) 40 Long Call Butterfly Example Max Profit $405.00 Max Loss $95.00 60 65 70 BEP $60.95 BEP $69.05
41 Long Call Butterfly: Over Time Buy 1 XYZ 60.00 call at $4.10 Sell 2 XYZ 65.00 calls at $2.00 Buy 1 XYZ 70.00 call at $0.85 XYZ at $61.00 Expiration 30 days If spread closed: Sell 1 XYZ 60.00 call + $3.05 Buy 2 XYZ 65.00 calls $ 1.05 Sell 1 XYZ 70.00 call + $0.25 net received: + $1.20 credit $0.95 net debit 30-day calls XYZ 60.00 call XYZ 65.00 call XYZ 70.00 call $3.05 $1.05 $0.25 Call butterfly sold for $1.20 Profit = $1.20 credit $0.95 debit = $0.25, or $25.00 total 42 Long Call Butterfly: Volatility Up Buy 1 XYZ 60.00 call at $4.10 Sell 2 XYZ 65.00 calls at $2.00 Buy 1 XYZ 70.00 call at $0.85 XYZ at $61.00 Expiration 30 days Volatility 35% 45% If spread closed: Sell 1 XYZ 60.00 call + $3.75 Buy 2 XYZ 65.00 calls $ 1.70 Sell 1 XYZ 70.00 call + $0.65 net received: + $1.00 credit $0.95 net debit 30-day calls XYZ 60.00 call XYZ 65.00 call XYZ 70.00 call $3.75 $1.70 $0.65 Put butterfly sold for $1.00 Profit = $1.00 credit $0.95 debit = $0.05, or $5.00 total
43 Long Call Butterfly: Volatility Down Buy 1 XYZ 60.00 call at $4.10 Sell 2 XYZ 65.00 calls at $2.00 Buy 1 XYZ 70.00 call at $0.85 XYZ at $61.00 Expiration 30 days Volatility 35% 25% If spread closed: Sell 1 XYZ 60.00 call + $2.35 Buy 2 XYZ 65.00 calls $ 0.50 Sell 1 XYZ 70.00 call + $0.05 net received: + $1.40 credit $0.95 net debit 30-day calls XYZ 60.00 call XYZ 65.00 call XYZ 70.00 call $2.35 $0.50 $0.05 Put butterfly sold for $1.40 Profit = $1.40 credit $0.95 debit = $0.45, or $45.00 total 44 Early Assignment for Dividend XYZ has risen short calls now in-the-money Early assignment possible before dividend on or just before ex-dividend date You might expect early assignment when expiration is relatively near dividend greater than short calls time value Action to avoid assignment, close the spread
45 Butterflies in General Call or put butterflies behavior and profit/loss profiles much the same choose suitable risk/reward that current premiums offer Unless all options expiring worthless, position will generally need to be totally or partially closed before expiration Since position is combination of 2 vertical spreads, you might consider exiting profitable spread before expiration and let unprofitable spread expire. Iron Butterfly
47 Iron Butterfly Iron butterfly to establish buy 1 put with lowest strike sell 1 put with middle strike sell 1 call with middle strike buy 1 call with highest strike Composition 2 ways to look at it bull put spread (credit) + bear call spread (credit) short straddle (credit) + long strangle (debit) Spread always established for net credit margin requirement (firm specific) 48 Iron Butterfly Long Put Long Call Short Put Short Call Bull Put Short 1 Put Short 1 Call Bear Call Long 1 Put Long 1 Call Iron Butterfly
49 Iron Butterfly Example Stock XYZ currently at $70.00 Spread: Buy 1 XYZ 60.00 put $0.60 Sell 1 XYZ 70.00 put + $3.80 Sell 1 XYZ 70.00 call + $4.10 Buy 1 XYZ 80.00 call $1.05 net received: + $6.25 credit XYZ 60.00-70.00-80.00 iron butterfly established for $6.25 credit, or $625.00 total 60-day options XYZ 60.00 put XYZ 65.00 put XYZ 70.00 put XYZ 70.00 call XYZ 75.00 call XYZ 80.00 call $0.60 $1.75 $3.80 $4.10 $2.20 $1.05 50 Iron Butterfly Example Buy 1 XYZ 60.00 put at $0.60 Sell 1 XYZ 70.00 put at $3.80 Sell 1 XYZ 70.00 call at $4.10 Buy 1 XYZ 80.00 call at $1.05 $6.25 net credit Downside break-even point middle strike net credit received $70.00 $6.25 = $63.75 Upside break-even point middle strike + net credit received $70.00 + $6.25 = $76.25
51 Iron Butterfly Example Buy 1 XYZ 60.00 put at $0.60 Sell 1 XYZ 70.00 put at $3.80 Sell 1 XYZ 70.00 call at $4.10 Buy 1 XYZ 80.00 call at $1.05 $6.25 net credit Maximum profit net credit received $6.25, or $625.00 total Maximum loss strike difference net credit received $10.00 $6.25 = $3.75, or $375.00 total 52 Iron Butterfly Example Max Profit $625.00 60 70 80 Max Loss $375.00 BEP $63.75 BEP $76.25
53 Iron Butterfly: Over Time Buy 1 XYZ 60.00 put at $0.60 Sell 1 XYZ 70.00 put at $3.80 Sell 1 XYZ 70.00 call at $4.10 Buy 1 XYZ 80.00 call at $1.05 $6.25 net credit XYZ at $70.00 Expiration 30 days If spread closed: Sell 1 XYZ 60.00 put + $0.15 Buy 1 XYZ 70.00 put $2.70 Buy 1 XYZ 70.00 call $2.85 Sell 1 XYZ 80.00 call + $0.35 net paid: $5.05 debit 30-day options XYZ 60.00 put $0.15 XYZ 70.00 put $2.70 XYZ 70.00 call $2.85 XYZ 80.00 call $0.35 Iron butterfly closed for $5.05 debit Profit = $6.25 credit $5.05 debit = $1.20, or $120.00 total 54 Iron Butterfly: Volatility Up Buy 1 XYZ 60.00 put at $0.60 Sell 1 XYZ 70.00 put at $3.80 Sell 1 XYZ 70.00 call at $4.10 Buy 1 XYZ 80.00 call at $1.05 $6.25 net credit XYZ at $70.00 Expiration 30 days Volatility 35% 45% If spread closed: Sell 1 XYZ 60.00 put + $0.45 Buy 1 XYZ 70.00 put $3.50 Buy 1 XYZ 70.00 call $3.70 Sell 1 XYZ 80.00 call + $0.80 net paid: $5.95 debit Iron butterfly closed for $5.95 debit Profit = $6.25 credit $5.95 debit = $0.30, or $30.00 total 30-day options XYZ 60.00 put XYZ 70.00 put XYZ 70.00 call XYZ 80.00 call $0.45 $3.50 $3.70 $0.80
55 Iron Butterfly: Volatility Down Buy 1 XYZ 60.00 put at $0.60 Sell 1 XYZ 70.00 put at $3.80 Sell 1 XYZ 70.00 call at $4.10 Buy 1 XYZ 80.00 call at $1.05 $6.25 net credit XYZ at $70.00 Expiration 30 days Volatility 35% 25% If spread closed: Sell 1 XYZ 60.00 put + $0.05 Buy 1 XYZ 70.00 put $1.95 Buy 1 XYZ 70.00 call $2.10 Sell 1 XYZ 80.00 call + $0.05 net paid: $3.95 debit Iron butterfly closed for $3.95 debit Profit = $6.25 credit $3.95 debit = $2.30, or $230.00 total 30-day options XYZ 60.00 put XYZ 70.00 put XYZ 70.00 call XYZ 80.00 call $0.05 $1.95 $2.10 $0.05 56 Butterfly Comparison Call or Put Butterfly Debit spreads Maximum profit lower (same strikes) Maximum loss higher (same strikes) Iron Butterfly Credit spread Maximum profit higher (same strikes) Maximum loss lower (same strikes) At expiration, maximum profit will occur with underlying closing exactly at middle strike price At expiration, pin risk is always a concern
Condor Spreads 58 Long Condor Basics Long condor spread to establish buy 1 option with lowest strike sell 1 option with higher strike sell 1 option with higher strike buy 1 option with highest strike Four strikes Always net debit All calls or all puts same underlying stock same expiration month same strike price increment always 1:1:1:1 ratio (long to short to short to long)
59 Long Condor Basics Investor s position long 1 lowest strike wing short 1 higher strike body short 1 higher strike body long 1 highest strike wing Investor is long condor has purchased condor for net debit Composition = two vertical spreads 1 bull spread and 1 bear spread 1 debit spread and 1 credit spread Profit potential and loss potential both limited 60 Long Condor Basics Neutral strategy Expectations for underlying trade in a range before expiration stabilize and close within a range at expiration Motivations profit from time decay profit from decreasing implied volatility Investor wants to profit from stable underlying market unwilling to accept risk of short strangle
61 Long Condor at Expiration Maximum profit limited strike increment net debit paid for spread if underlying closes at or between middle (short) strikes Maximum loss limited net debit paid for spread if underlying at or below lowest strike if underlying at or above highest strike Break-even points downside lowest strike + net debit paid upside highest strike net debit paid 62 Long Condor at Expiration Maximum Profit Lowest Strike Higher Strike Higher Strike Highest Strike Maximum Loss Downside BEP Upside BEP
63 Long Condor Basics Criteria for underlying selection higher priced stocks/etfs more available strikes sufficient liquidity Possible requirements for trading condor spreads accounts approved at higher levels minimum equity amounts firm-specific Margin net debit paid for in full greater initial margin amount possible firm-specific Long Call Condor
65 Long Call Condor Long call condor to establish buy 1 call with lowest strike sell 1 call with higher strike sell 1 call with higher strike buy 1 call with highest strike Composition = 2 call vertical spreads bull call spread (debit) bear call spread (credit) 66 Long Call Condor Long Call Long Call Short Call Short Call Bull Call Bear Call Short 1 Call Short 1 Call Long 1 Call Long 1 Call Long Call Condor
67 Long Call Condor Example Stock XYZ currently at $82.00 Spread: Buy 1 XYZ 75.00 call $9.00 Sell 1 XYZ 80.00 call + $5.90 Sell 1 XYZ 85.00 call + $3.60 Buy 1 XYZ 90.00 call $2.00 net cost: $1.50 debit XYZ 75.00-80.00-85.00-90.00 call condor purchased for $1.50 or $150.00 total Available 60-day calls XYZ 70.00 call XYZ 75.00 call XYZ 80.00 call XYZ 85.00 call XYZ 90.00 call XYZ 95.00 call $13.00 $9.00 $5.90 $3.60 $2.00 $1.05 68 Long Call Condor Example Buy 1 XYZ 75.00 call at $9.00 Sell 1 XYZ 80.00 call at $5.90 Sell 1 XYZ 85.00 call at $3.60 Buy 1 XYZ 90.00 call at $2.00 $1.50 net debit Downside break-even point lowest strike + net debit paid $75.00 + $1.50 = $76.50 Upside break-even point highest strike net debit paid $90.00 $1.50 = $88.50
69 Long Call Condor Example Buy 1 XYZ 75.00 call at $9.00 Sell 1 XYZ 80.00 call at $5.90 Sell 1 XYZ 85.00 call at $3.60 Buy 1 XYZ 90.00 call at $2.00 $1.50 net debit Maximum profit strike increment net debit paid $5.00 $1.50 = $3.50, or $350.00 total Maximum loss net debit paid $1.50, or $150.00 total 70 Long Call Condor Example Buy 1 XYZ 75.00 call at $9.00 Sell 1 XYZ 80.00 call at $5.90 Sell 1 XYZ 85.00 call at $3.60 Buy 1 XYZ 90.00 call at $2.00 $1.50 net debit XYZ Price Long 1 75.00 Call Profit/(Loss) Short 1 80.00 Call Profit/(Loss) Short 1 85.00 Call Profit/(Loss) $90.00 $88.50 $87.00 $6.00 $4.50 $3.00 ($4.10) ($2.60) ($1.10) ($1.40) $0.10 $1.60 $85.00 $1.00 $0.90 $3.60 $80.00 ($4.00) $5.90 $3.60 $78.00 ($6.00) $5.90 $3.60 $76.50 ($7.50) $5.90 $3.60 $75.00 ($9.00) $5.90 $3.60 Long 1 90.00 Call Profit/(Loss) ($2.00) ($2.00) ($2.00) ($2.00) ($2.00) ($2.00) ($2.00) ($2.00) Combined Profit/(Loss) ($1.50) 0 $1.50 $3.50 $3.50 $1.50 0 ($1.50)
71 Long Call Condor Example Max Profit $350.00 Max Loss $150.00 75 90 80 85 BEP $76.50 BEP $88.50 72 Long Call Condor Over Time Buy 1 XYZ 75.00 call at $9.00 Sell 1 XYZ 80.00 call at $5.90 Sell 1 XYZ 85.00 call at $3.60 Buy 1 XYZ 90.00 call at $2.00 $1.50 net debit XYZ at $82.00 Expiration 30 days If spread closed: Sell 1 XYZ 75.00 call + $8.00 Buy 1 XYZ 80.00 call $4.50 Buy 1 XYZ 85.00 call $2.15 Sell 1 XYZ 90.00 call + $0.85 net received: + $2.20 credit 30-day calls XYZ 75.00 call $8.00 XYZ 80.00 call $4.50 XYZ 85.00 call $2.15 XYZ 90.00 call $0.85 Call condor sold for $2.20 Profit = $2.20 credit $1.50 debit = $0.70, or $70.00 total
73 Long Call Condor: Volatility Up Buy 1 XYZ 75.00 call at $9.00 Sell 1 XYZ 80.00 call at $5.90 Sell 1 XYZ 85.00 call at $3.60 Buy 1 XYZ 90.00 call at $2.00 $1.50 net debit XYZ at $82.00 Expiration 30 days Volatility 35% 45% If spread closed: Sell 1 XYZ 75.00 call + $8.60 Buy 1 XYZ 80.00 call $5.30 Buy 1 XYZ 85.00 call $3.00 Sell 1 XYZ 90.00 call + $1.60 net received: + $1.90 credit Call condor sold for $1.90 Profit = $1.90 credit $1.50 debit = $0.40, or $40.00 total 30-day calls XYZ 75.00 call XYZ 80.00 call XYZ 85.00 call XYZ 90.00 call $8.60 $5.30 $3.00 $1.60 74 Long Call Condor: Volatility Down Buy 1 XYZ 75.00 call at $9.00 Sell 1 XYZ 80.00 call at $5.90 Sell 1 XYZ 85.00 call at $3.60 Buy 1 XYZ 90.00 call at $2.00 $1.50 net debit XYZ at $82.00 Expiration 30 days Volatility 35% 25% If spread closed: Sell 1 XYZ 75.00 call + $7.50 Buy 1 XYZ 80.00 call $3.60 Buy 1 XYZ 85.00 call $1.25 Sell 1 XYZ 90.00 call + $0.30 net received: + $2.95 credit Call condor sold for $2.95 Profit = $2.95 credit $1.50 debit = $1.45, or $145.00 total 30-day calls XYZ 75.00 call XYZ 80.00 call XYZ 85.00 call XYZ 90.00 call $7.50 $3.60 $1.25 $0.30
75 Early Assignment for Dividend XYZ has risen short call(s) now in-the-money Early assignment possible before dividend on or just before ex-dividend date You might expect early assignment when expiration is relatively near dividend greater than short call s(s ) time value Action to avoid assignment, close the spread 76 Condors in General Call or put condors behavior and profit/loss profiles much the same choose suitable risk/reward that current premiums offer Unless all options expiring worthless, position will generally need to be totally or partially closed before expiration Since position is combination of 2 vertical spreads, you might consider exiting profitable spread before expiration and let unprofitable spread expire
Iron Condor 78 Iron Condor Iron condor to establish buy 1 put with lowest strike sell 1 put with higher strike sell 1 call with higher strike buy 1 call with highest strike Composition 2 ways to look at it bull put spread (credit) + bear call spread (credit) short strangle (credit) + long wider strangle (debit) Spread always established for net credit margin requirement (firm specific)
79 Iron Condor Long Put Long Call Short Put Short Call Bull Put Bear Call Short 1 Put Short 1 Call Long 1 Put Long 1 Call Iron Condor 80 Iron Condor Example Stock XYZ currently at $66.00 Spread: Buy 1 XYZ 60.00 put $1.30 Sell 1 XYZ 65.00 put + $3.10 Sell 1 XYZ 70.00 call + $2.30 Buy 1 XYZ 75.00 call $1.10 net received: + $3.00 credit XYZ 60.00-65.00-70.00-75.00 iron condor established for $3.00 credit, or $300.00 total 60-day options XYZ 50.00 put XYZ 60.00 put XYZ 65.00 put XYZ 70.00 call XYZ 75.00 call XYZ 80.00 call $0.10 $1.30 $3.10 $2.30 $1.10 $0.45
81 Iron Condor Example Buy 1 XYZ 60.00 put at $1.30 Sell 1 XYZ 65.00 put at $3.10 Sell 1 XYZ 70.00 call at $2.30 Buy 1 XYZ 75.00 call at $1.10 $3.00 net credit Downside break-even point short put strike net credit received $65.00 $3.00 = $62.00 Upside break-even point short call strike + net credit received $70.00 + $3.00 = $73.00 82 Iron Condor Example Buy 1 XYZ 60.00 put at $1.30 Sell 1 XYZ 65.00 put at $3.10 Sell 1 XYZ 70.00 call at $2.30 Buy 1 XYZ 75.00 call at $1.10 $3.00 net credit Maximum profit net credit received $3.00, or $300.00 total Maximum loss strike difference net credit received $5.00 $3.00 = $2.00, or $200.00 total
83 Iron Condor Example Max Profit $300.00 Max Loss $200.00 60 75 65 70 BEP $62.00 BEP $73.00 84 Iron Condor: Over Time Buy 1 XYZ 60.00 put at $1.30 Sell 1 XYZ 65.00 put at $3.10 Sell 1 XYZ 70.00 call at $2.30 Buy 1 XYZ 75.00 call at $1.10 $3.00 net credit XYZ at $66.00 Expiration 30 days If spread closed: Sell 1 XYZ 60.00 put + $0.55 Buy 1 XYZ 65.00 put $2.10 Buy 1 XYZ 70.00 call $1.25 Sell 1 XYZ 75.00 call + $0.35 net paid: $2.45 debit 30-day options XYZ 60.00 put $0.55 XYZ 65.00 put $2.10 XYZ 70.00 call $1.25 XYZ 75.00 call $0.35 Iron condor closed for $2.45 debit Profit = $3.00 credit $2.45 debit = $0.55, or $55.00 total
85 Iron Condor: Volatility Up Buy 1 XYZ 60.00 put at $1.30 Sell 1 XYZ 65.00 put at $3.10 Sell 1 XYZ 70.00 call at $2.30 Buy 1 XYZ 75.00 call at $1.10 $3.00 net credit XYZ at $66.00 Expiration 30 days Volatility 35% 45% If spread closed: Sell 1 XYZ 60.00 put + $1.05 Buy 1 XYZ 65.00 put $2.85 Buy 1 XYZ 70.00 call $1.90 Sell 1 XYZ 75.00 call + $0.80 net paid: $2.90 debit Iron condor closed for $2.90 debit Profit = $3.00 credit $2.90 debit = $0.10, or $10.00 total 30-day options XYZ 60.00 put XYZ 65.00 put XYZ 70.00 call XYZ 75.00 call $1.05 $2.85 $1.90 $0.80 86 Iron Condor: Volatility Down Buy 1 XYZ 60.00 put at $1.30 Sell 1 XYZ 65.00 put at $3.10 Sell 1 XYZ 70.00 call at $2.30 Buy 1 XYZ 75.00 call at $1.10 $3.00 net credit XYZ at $66.00 Expiration 30 days Volatility 35% 25% If spread closed: Sell 1 XYZ 60.00 put + $0.20 Buy 1 XYZ 65.00 put $1.35 Buy 1 XYZ 70.00 call $0.60 Sell 1 XYZ 75.00 call + $0.10 net paid: $1.65 debit Iron condor closed for $1.65 debit Profit = $3.00 credit $1.65 debit = $1.35, or $135.00 total 30-day options XYZ 60.00 put XYZ 65.00 put XYZ 70.00 call XYZ 75.00 call $0.20 $1.35 $0.60 $0.10
87 Condor Comparison Call or Put Condor Debit spreads Maximum profit lower (same strikes) Maximum loss higher (same strikes) Iron Condor Credit spread Maximum profit higher (same strikes) Maximum loss lower (same strikes) At expiration, maximum profit will occur with underlying closing at or between the two middle strike prices At expiration, pin risk is always a concern 88 Iron Butterfly vs. Iron Condor Iron Butterfly at Expiration Maximum loss generally lower Maximum profit (net credit) generally higher Maximum profit at single strike price (middle) Iron Condor at Expiration Maximum loss generally higher Maximum profit (net credit) generally lower Maximum profit within range of strike prices (middle two)
89 In Conclusion Butterflies and condors (including iron versions) neutral strategies tradeoff for limited loss potential limited profit potential opportunity to sell options with limited risk Probability of maximum profit at expiration butterfly lower condor higher Margin, as well as account approval, may be required to trade these strategies 90 For More Information www.optionseducation.org 1 888 OPTIONS
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