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Short Condor

short-condor

1. Definition

The Short Call Condor is a combination between the Bear and the Bull Spreads, using four Calls with different exercise prices, for a same expiration date. In this strategy, two ITM sales and two OTM operations are made, ITMs for the lower exercise price and OTMs with the higher prices, forming a condor wing on graphs. This is not a very common strategy, once some other methods are quite similar and offer better results (like straddles or strangles), even though the condor is less risky.

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.

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


2. Objective

Making money in a high volatile market, where the assets are floating frequently, being off limits from options and extrapolating the typical pricing range of shares. The strategy may produce earnings from both ups and downs, but might be leading to losses if shares keep steady.


3. How it works

In this strategy, the investor sells an ITM Call and an OTM Call, receiving a premium. At the same time, another ITM and OTM Calls are purchased, at intermediate prices, paying a premium. Initial results from the operation are a credit, as received premiums exceed those paid. The graphical explanation is below:

Selling a Call + Buying a Call + Selling a Call + Buying a Call = Short Condor

Selling a Call

gráfico Short call_clean

+

Buying a Call

gráfico Long call_clean

+

Selling a Call

gráfico Short call_clean

+

Buying a Call

gráfico Long call_clean

 =

Short Condor

gráfico Short Condor call_clean

Caption:

Red = Losses

Yellow = Losses with premiums paid

Green = Profits

Earnings: profits are always limited and happen out of the “body” of the graph, in other words, everytime a value is located in the condor’s “wings”, profits are made. The maximum earnings happen when the realizing prices are below the first ITM Call sold or above the OTM Call sold, always being the net credit received from the sale and purchase of options.

Losses: losses are also limited. The maximum losses happen if prices don’t move through the expiration dates, standing within the condor’s “body” in the graph. For this situation, losses are equal to the ITM and OTM Calls purchased minus the premium received from selling Calls.


4. Example

Consider the following data:

Asset

Vale

Date

09/10/2013

Maturity

10/21/2013

Share prices

32,15

Days before the expiry date

41

Number of options

1.000

To set up this operation, the investor needs to sell a VALEJ30 ITM Call, receiving a premium of R$ 0.25 option, and sell another VALEJ33 OTM Call, receiving a premium of R$ 1.34 per option. At the same time, he must buy an ITM  Call VALEJ31, paying R$ 0.45 of premium per option, and also buying an OTM Call VALEJ33, paying R$ 0,80. Look the following summary:

Summary:

Option Type

Asset

Series

Number of options

Premium

Strike

Liquidation amount

Call Sold

Vale

VALEJ30

-1.000

0,25

30

R$ 250,00

Call Purchased

Vale

VALEJ31

1.000

-0,45

31

R$ -450,00

Call Purchased

Vale

VALEJ32

1.000

-0,80

32

R$ -800,00

Call Sold

Vale

VALEJ33

-1.000

1,34

33

R$ 1.340,00

Total

0,34

R$ 340,00

By the expiry date, we’ll have the following results, depending on latest prices:

Share prices on expiry date

Call Sold

Call Purchased

Call Purchased

Call Sold

Strategy Results

R$ 26,00

250

-450

-800

1.340

340

R$ 27,00

250

-450

-800

1.340

340

R$ 28,00

250

-450

-800

1.340

340

R$ 29,00

250

-450

-800

1.340

340

R$ 30,00

250

-450

-800

1.340

340

R$ 31,00

-750

-450

-800

1.340

-660

R$ 32,00

-1.750

550

-800

1.340

-660

R$ 33,00

-2.750

1.550

200

1.340

340

R$ 34,00

-3.750

2.550

1.200

340

340

R$ 35,00

-4.750

3.550

2.200

-660

340

R$ 36,00

-5.750

4.550

3.200

-1.660

340

R$ 37,00

-6.750

5.550

4.200

-2.660

340

Results:

If Petrobras shares are below R$ 30.34 by the expiry date or above R$ 32.66, the operation results in profits. In this case, none of the options will be exercised, and the investor keeps the totality of the premiums. For the range between R$ 30.35 and R$ 32.67, the operation results in losses. In this case, the option VALEJ30 is exercised by his counterpart, and he will be forced to sell shares at R$ 30.00. If share prices are over R$ 31.00, he will exercised the ITM option, buying the share at R$ 31,00. If share prices are over R$ 32.00, the OTM will be exercise by his counterpart, and he will be forced to sell the shares at R$ 32,00. Lastly, if prices are over R$ 33.00, he can buy shares for R$ 33.00. Look the graph below:

Short Call Condor_pronto

Caption:

Red = Losses

Yellow = Tiny losses

Green = Profits

Earnings: the investor makes profits if share prices are lower than R$ 30.34 or higher than R$ 32.66, with maximum earnings of R$ 340.00. The maximum earnings will always be equal to the sum of premiums received minus those which were paid.

Losses: the investor accumulates losses if Vale’s shares are in the range of R$ 30.34 and R$ 32.65 by the expiry date. For this range, we have the following situation:

VALEJ30: the investor will be exercised on VALEJ30 and forced to sell shares at R$ 30.00. However, the gets a premium of R$ 0.25 per option.

VALEJ31: if prices are over R$ 31.00 at the maturity, the investor may realize the options, buying shares for R$ 31.00 and mitigating the losses from VALEJ30.

VALEJ32: if prices are higher than R$ 32.00, he can buy shares for R$ 32.00, making profits. However, as he paid a premium for those options, shall be deducted from the profit. Below this price, the option just expire.

VALEJ33: the option is not exercised below R$ 33.00. Over R$ 33,00, the investor needs to sell share for this strike price, accumulating losses from the move. Premiums received for selling the option can offset part of the losses, though.

Maximum losses reach R$ 660, when share prices are between R$ 31.00 and 32.00.

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