# Long condor spread with puts

• The Options Institute at CBOE®

### Goal

To profit from neutral stock price action between the middle two strike prices of the position with limited risk.

### Explanation

#### Example of long condor spread with puts

 Buy 1 XYZ 110 put at 8.25 (8.25) Sell 1 XYZ 105 put at 4.65 4.65 Sell 1 XYZ 100 put at 2.10 2.10 Buy 1 XYZ 95 put at 0.70 (0.70) Net cost = (2.20)

A long condor spread with puts is a four-part strategy that is created by buying one put at a higher strike price, selling one put with a lower strike price, selling another put with an even lower strike price and buying one more put with an even lower strike price. All puts have the same expiration date, and the strike prices are equidistant. In the example above, one 110 Put is purchased, one 105 Put is sold, one 100 Put is sold, and one 95 Put is purchased. This strategy is established for a net debit, and both the potential profit and maximum risk are limited. The maximum profit is realized if the stock price is between the middle two strike prices on the expiration date. The maximum risk is the net cost of the strategy including commissions and is realized if the stock price is above the highest strike price or below the lowest strike price at expiration.

This is an advanced strategy because the profit potential is small in dollar terms and because “costs” are high. Given that there are four strike prices and four options, there are multiple commissions and bid-ask spreads when opening the position and again when closing it. As a result, it is essential to open and close the position at “good prices.” It is also important to trade a condor with acceptable risk/reward ratios.

### Maximum profit

The maximum profit potential is equal to the difference between the strike prices less the net cost of the position including commissions, and this profit is realized if the stock price is between the middle strike prices at expiration.

In the example above, the difference between the strike prices is 5.00, and the net cost of the strategy is 2.20, not including commissions. The maximum profit, therefore, is 2.80 less commissions.

### Maximum risk

The maximum risk is the net cost of the strategy including commissions, and there are two possible outcomes in which a loss of this amount is realized. If the stock price is above the highest strike price at expiration, then all puts expire worthless and the full cost of the strategy including commissions is lost. Also, if the stock price is below the lowest strike price at expiration, then all puts are in the money and the condor spread position has a net value of zero at expiration. As a result, the full cost of the position including commissions is lost.

### Breakeven stock price at expiration

There are two breakeven points. The lower breakeven point is the stock price equal to the lowest strike price plus the cost of the position including commissions. The upper breakeven point is the stock price equal to the highest strike price minus the cost of the position.

### Profit/Loss diagram and table: long condor spread with puts

 Buy 1 XYZ 110 put at 8.25 (8.25) Sell 1 XYZ 105 put at 4.65 4.65 Sell 1 XYZ 100 put at 2.10 2.10 Buy 1 XYZ 95 put at 0.70 (0.70) Net cost = (2.20)
Stock Price at Expiration Long 1 110 Put Profit/(Loss) at Expiration Short 1 105 Put Profit/(Loss) at Expiration Short 1 100 Put Profit/(Loss)at Expiration Long 1 95 Put Profit/(Loss)At Expiration Net Profit/(Loss) at Expiration
115 (8.25) +4.65 +2.10 (0.70) (2.20)
110 (8.25) +4.65 +2.10 (0.70) (2.20)
105 (3.25) +4.65 +2.10 (0.70) +2.80
100 +1.75 (0.35) +2.10 (0.70) +2.80
95 +6.75 (5.35) (2.90) (0.70) (2.20)
90 +11.75 (5.35) (2.90) +4.30 (2.20)

### Appropriate market forecast

A long condor spread with puts realizes its maximum profit if the stock price is between the middle strike prices at expiration. The forecast, therefore, must be for neutral stock price action in the range of maximum profit.

If the stock price is above or below the range of maximum profit when the position is established, then the forecast must be for a directional stock price move into the range of maximum profit.

### Strategy discussion

A long condor spread with puts is the strategy of choice when the forecast is for stock price action in the range of maximum profit, which is between the middle strike prices of the spread. Long condor spreads profit from time decay; but, unlike a short straddle or short strangle, the potential risk of a long condor spread is limited. The tradeoff is that a long condor spread has a much lower profit potential in dollar terms than a comparable short straddle or short strangle. Also, the commissions for a condor spread are higher than for a straddle or strangle.

Long condor spreads are sensitive to changes in volatility (see Impact of Change in Volatility). The net price of a condor spread falls when volatility rises and rises when volatility falls. Consequently some traders buy condor spreads when they forecast that volatility will fall. Since the volatility in option prices tends to fall sharply after earnings reports, some traders will buy a condor spread immediately before the report. The potential profit is “high” in percentage terms and risk is limited to the cost of the position including commissions. Success of this approach to buying condor spreads requires that the stock price stay between the lower and upper strikes price of the condor. If the stock price rises or falls too much, then a loss will be incurred.

If volatility is constant, long condor spreads with puts do not rise in value and, therefore, do not show much of a profit, until it is very close to expiration and the stock is between the middle strike prices. In contrast, short straddles and short strangles begin to show at least some profit early in the expiration cycle as long as the stock price does not move out of the profit range.

Furthermore, while the potential profit of a long condor spread is a “high percentage profit on the capital at risk,” the typical dollar cost of one condor spread is “low.” As a result, it is often necessary to trade a large number of condor spreads if the goal is to earn a profit in dollars equal to the hoped-for dollar profit from a short straddle or strangle. Also, one should not forget that the risk of a long condor spread is still 100% of the cost of the position. Therefore, if the stock price begins to fall below the lowest strike price or to rise above the highest strike price, a trader must be ready to close out the position before a large percentage loss is incurred.

Patience and trading discipline are required when trading long condor spreads. Patience is required because this strategy profits from time decay, and stock price action can be unsettling as it rises and falls around the center strike price as expiration approaches. Trading discipline is required, because, as expiration approaches, “small” changes in stock price can have a high percentage impact on the price of a condor spread. Traders must, therefore, be disciplined in taking partial profits if possible and also in taking “small” losses before the losses become “big.”

### Impact of stock price change

“Delta” estimates how much a position will change in price as the stock price changes. Long puts have negative deltas, and short puts have positive deltas.

If the stock price is between the lowest and highest strike prices, then, regardless of time to expiration, the net delta of a long condor spread remains close to zero until a few days before expiration. If the stock price is above the highest strike price in a long condor spread with puts, then the net delta is slightly negative. If the stock price is below the lowest strike price, then the net delta is slightly positive. Overall, a long condor spread with puts does not profit from stock price change; it profits from time decay as long as the stock price is between the breakeven points.

### Impact of change in volatility

Volatility is a measure of how much a stock price fluctuates in percentage terms, and volatility is a factor in option prices. As volatility rises, option prices tend to rise if other factors such as stock price and time to expiration remain constant. Long options, therefore, rise in price and make money when volatility rises, and short options rise in price and lose money when volatility rises. When volatility falls, the opposite happens; long options lose money and short options make money. “Vega” is a measure of how much changing volatility affects the net price of a position.

Long condor spreads with puts have a negative vega. This means that the price of a long condor spread falls when volatility rises (and the spread loses money). When volatility falls, the price of a long condor spread rises (and the spread makes money). Long condor spreads, therefore, should be purchased when volatility is “high” and forecast to decline.

### Impact of time

The time value portion of an option’s total price decreases as expiration approaches. This is known as time erosion. “Theta” is a measure of how much time erosion affects the net price of a position. Long option positions have negative theta, which means they lose money from time erosion, if other factors remain constant; and short options have positive theta, which means they make money from time erosion.

A long condor spread with puts has a net positive theta – it profits from time decay – as long as the stock price is in a range between the lowest and highest strike prices. If the stock price moves out of this range, however, the theta becomes negative as expiration approaches.

### Risk of early assignment

Stock options in the United States can be exercised on any business day, and holders of short stock option positions have no control over when they will be required to fulfill the obligation. Therefore, the risk of early assignment is a real risk that must be considered when entering into positions involving short options.

While the long puts in a long condor spread have no risk of early assignment, the short puts do have such risk. Early assignment of stock options is generally related to dividends. Short puts that are assigned early are generally assigned on the ex-dividend date. In-the-money puts whose time value is less than the dividend have a high likelihood of being assigned.

If one short put is assigned (most likely the higher-strike short put), then 100 shares of stock are purchased and the long puts (lowest and highest strike prices) and the other short put remain open. If a long stock position is not wanted, it can be closed in one of two ways. First, 100 shares can be sold in the marketplace. Second, the long 100-share position can be closed by exercising the highest-strike long put. Remember, however, that exercising a long put will forfeit the time value of that put. Therefore, it is generally preferable to sell shares to close the long stock position and then sell the long put. This two-part action recovers the time value of the long put. One caveat is commissions. Selling shares to close the long stock position and then selling the long put is only advantageous if the commissions are less than the time value of the long put.

If both of the short puts are assigned, then 200 shares of stock are purchased and the long puts (lowest and highest strike prices) remain open. Again, if a long stock position is not wanted, it can be closed in one of two ways. Either 200 shares can be sold in the marketplace, or both long puts can be exercised. However, as discussed above, since exercising a long put forfeits the time value, it is generally preferable to sell shares to close the long stock position and then sell the long puts. The caveat, as mentioned above, is commissions. Selling shares to close the long position and then selling the long puts is only advantageous if the commissions are less than the time value of the long puts.

Note, however, that whichever method is used, selling stock and selling the long put or exercising the long put, the date of the stock sale will be one day later than the date of the purchase. This difference will result in additional fees, including interest charges and commissions. Assignment of a short option might also trigger a margin call if there is not sufficient account equity to support the stock position created.

### Potential position created at expiration

The position at expiration of a long condor spread with puts depends on the relationship of the stock price to the strike prices of the spread. If the stock price is above the highest strike price, then all puts expire worthless, and no position is created.

If the stock price is below the highest strike and at or above the second-highest strike, then the highest strike long put is exercised, and the other three puts expire worthless. The result is that 100 shares of stock are sold short and a stock position of short 100 shares is created.

If the stock price is below the second-highest strike and at or above the second-lowest strike, then the highest strike long put is exercised and the second-highest strike short put is assigned. The result is that 100 shares are purchased and 100 shares are sold. The net result is no position, although one stock buy commission and one stock sell commission have been incurred.

If the stock price is below the second-lowest strike and at or above the lowest strike, then the highest-strike long put is exercised, and both short puts are assigned. The result is that 200 shares are purchased and 100 shares are sold. The net result is a stock position of long 100 shares.

If the stock price is below the lowest strike, then both long puts (lowest and highest strikes) are exercised and both short puts (middle two strikes) are assigned. The result is that 200 shares are purchased and 200 shares are sold. The net result is no position, although two stock buy and sell commissions have been incurred.

### Other considerations

A long condor spread with puts can also be described as the combination of a bear put spread and a bull put spread. The bear put spread is the long highest-strike put combined with the short second-highest strike put, and the bull put spread is the short second-lowest strike put combined with the long lowest-strike put.

The term “condor” in the strategy name is thought to have originated from the profit-loss diagram. A condor is a bird with an exceptionally long wing span for its body size. The horizontal line representing the range of maximum profit in the middle of the diagram looks vaguely like the body a condor and the horizontal lines stretching out above the highest strike and below the lowest strike look vaguely like the wings of a condor.