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Long Condor

long-condor

1. Definition

The Long Call Condor combines the Bull Spread and the Bear Spread, by using four Calls with different exercise prices and same expiration date. In this strategy, an ITM and an OTM Call are purchased, with a lower and a higher price, respectively, and another ITM/OTM pair is sold, at average prices. The strategy is quite popular and pays off the underlying risk, with a relatively low cost.

Buying a Call In-The-Money: buying a Call at a strike below the current share prices. Buying a Call gives you rights of buying a share until the expiry date, for the strike price.

Buying a Call Out-The-Money: buying a Call at prices above the share prices. Buying a Call gives you the right of buying a share until the expiry date, for an established price.

Selling a Call In-The-Money: selling Call at prices below the share prices. Selling a Call forces you to sell a share until the expiry date, for an established price.

Selling a Call Out-The-Money: selling a Call at prices above the share prices. Selling a Call forces you to sell a share until the expiry date, for an established price


2. Objective

Making money in a neutral market, where assets are not floating much and are keeping the same pricing levels. The best to do is to set up this strategy for more distant months, to reduce premiums, in a share with low standard deviation. This operations results in limited gains in a neutral market and may lead to limited losses if markets soar or drop too much.


3. How it works

In this strategy, an ITM and an OTM Calls are purchased, paying a premium. At the same time, another set with ITM/OTM Calls is sold at average prices, receiving a premium. Initial results are negative, as premiums paid exceed those received by the investor. The graphs result in:

Buying a Call + Selling a Call + Buying a Call + Selling a Call = Long Condor

Buying a Call

gráfico Long call_clean

+

Selling a Call

gráfico Short call_clean

+

Buying a Call

gráfico Long call_clean

+

Selling a Call

gráfico Short call_clean

 =

Long Condor

 gráfico Long Call Condor_clean

Caption:

Red = Losses

Yellow = Losses from premiums paid

Green = Profits

Earnings: profits are always limited, and happen when prices are inside the range or the “body” in the graph. Gains are equal to the ITM sale minus the purchased ITM or the OTM sold minus the purchased OTM, minus the net debit of the premium of options.

Losses: also limited. The maximum losses happen when share prices by the expiration date changes hugely, and stand over the condor’s wings in the graph. Losses are equal to the net spread between the options purchased and those which were sold – i.e. the operation setup costs.


4. Example

Consider the following data:

Asset

Petrobrás

Date

09/10/2013

Maturity

10/21/2013

Share prices

18,72

Days before expiration

41

Number of options

1.000

To set up this operation, the investor needs to buy a PETRJ18 ITM Call, paying a premium of R$ 1.60 per option and buy a PETRJ22 OTM Call, paying a premium of R$ 0.04 each. At the same time, he needs to sell PETRJ19 ITM Call, receiving R$ 1.00 of premiums, and a PETRJ21 OTM Call, earning R$ 0.11 per option. Look the summary:

Summary:

Type of Option

Asset

Series

Number of options

Premium

Strike

Liquidation

Buying a Call

Petrobrás

PETRJ18

1.000

-1,60

18

R$ -1.600

Selling a Call

Petrobrás

PETRJ19

-1.000

1,00

19

R$ 1.000

Selling a Call

Petrobrás

PETRJ21

-1.000

0,11

21

R$ 110

Buying a Call

Petrobrás

PETRJ22

1.000

-0,04

22

R$ -40

Total

0,53

R$ -530

By the expiration, results will depend on the pricing of the underlying asset, as follows:

Share prices on expiration

Buying a Call

Selling a Call

Selling a Call

Buying a Call

Results

R$ 15,00

-1.600

1.000

110

-40

-530

R$ 16,00

-1.600

1.000

110

-40

-530

R$ 17,00

-1.600

1.000

110

-40

-530

R$ 18,00

-1.600

1.000

110

-40

-530

R$ 19,00

-600

1.000

110

-40

470

R$ 20,00

400

0

110

-40

470

R$ 21,00

1.400

-1.000

110

-40

470

R$ 22,00

2.400

-2.000

-890

-40

-530

R$ 23,00

3.400

-3.000

-1.890

960

-530

R$ 24,00

4.400

-4.000

-2.890

1.960

-530

R$ 25,00

5.400

-5.000

-3.890

2.960

-530

R$ 26,00

6.400

-6.000

-4.890

3.960

-530

Results:

If prices for Petrobrás shares reach over R$ 19,00, the investor exercises his buying option PETRJ18, and is able to buy a share for R$ 18,00. However, if share prices reach R$ 19.00, he is also exercised because he sold a Call, being forced to sell shares at R$ 19.00. If prices reach more than R$ 21.00, he will be forced to sell again by the option PETRJ21, and if prices exceed R$ 22.00, he can buy a share for this price. Look the graph below.

Long Condor_pronto

Caption:

Red = Losses

Yellow = Losses from premiums paid

Green = Profits

Earnings: the operations results in profits if Petrobras shares stand between R$ 18.54 and R$ 21.46. For this range, we have the following situation:

PETRJ18: the investor exercises rights of buying through the option PETRJ18, buying shares for R$ 18.00. After  at, he can sell the shares for market prices, or R$ 18.53, making R$ 0.53 per share in profits. However, as he paid R$ 1.60 in premiums per option, losses reach R$ 1.06 per option.

PETRJ19: if the underlying shares reach prices below R$ 19.00, the option just expires and the investor keeps the R$ 1.00 premium received per share. For any above this mark, the option shall be exercised. If prices reach R$ 19.40, for instance, the investor needs to sell shares for this price, making R$ 0.40 in losses per option (R$ 19.00 – R$ 19.40 = R$ 0.40). However, as he got R$ 1.00 in premiums, profits per option reach R$ 0.60.

PETRJ21: the option won’t be exercised until it gets to R$ 21.00 or more. Above this value, the investor is forced to sell shares. In this cases, he still keeps with the premiums received, of R$ 0.11 per option.

PETRJ22: the option shall not be realized for less than R$ 22.00, accumulating losses of R$ 0.04, from buying the options.

Results: – R$ 1,07 + R$ 1,00 + R$ 0,11 R$ -0,04 = R$ 0,01

Maximum profits reach R$ 0.46 per share, while share prices vary between R$ 19.00 and R$ 21.00.

Losses: the investor can lose money if shares drop below R$ 18.53 or rise to over R$ 21.47, with maximum losses of R$ 530.00. Losses are always limited to the costs for set up the operation, that is, the sum of premiums paid minus the sum of the premiums received.

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