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The "short condor" spread is one of the more unique trades you can make trading options. The name is somewhat misleading so I want to show how this trade works. Unlike the "butterfly" spread, where you want to see little movement in the underlying stock to profit, the "short condor" is the opposite, in that it benefits from a large price swing. It is a limited upside, limited risk strategy. There are many benefits to this trade and I will detail those in this article.

In short, the "short condor spread" is a bear call spread and a bull call spread put together.

One of the best aspects of the short condor spread is that you know what you risk is on the trade immediately, as well as your potential profits. The profits, while limited, can still be substantial. I recommend using this type of spread with a company that reports earnings during a specific week. Having too much time premium left is not necessarily a good thing. In fact, I believe that weekly options are one of the best ways to use the short condor, as the stock will not have time to rebound quickly enough to land in the middle of the strike prices, which is the worst possible scenario using this strategy.

When placing this trade, there is an option requirement. It is also important to note that your broker must approve you for this type of trading.

The short condor must only be used with volatile stocks. We want to see a large move quickly, either up or down, to profit. I will show two examples in this article.

The downside to this trade is that if the stock makes a massive move after earnings, your gains are capped to the net credit received when placing the trade. However, you will know your exact profits if the trade works out from the outset because the trade is made with a net credit to the buyer. This is the most you can profit on the trade.

Now, let's get to the parameters of the trade and how to place it. There are four (4) "legs" to the strategy. For simplification purposes, I will use the minimal amount of contracts needed to accurately place the trade:

Short Condor Construction

  • Buy 1 I in-the-money (ITM) Call)
  • Sell 1 in-the-money call (ITM) (Lower Strike Price)
  • Buy 1 out-of-the-money (OTM) call
  • Sell 1 out-of-the-money (OTM) Call (Higher Strike Price)

Profit/Loss Breakdown:

Max Profit = Net Premium Received - Commissions Paid

  • Maximum Profit = Net Premium Received - Commissions Paid
  • Maximum Profit Achieved When Price of Underlying <= Strike Price of Lower Strike Short Call OR Price of Underlying >= Strike Price of Higher Strike Short Call

Max Loss:

  • Maximum Loss = Strike Price of Lower Strike Long Call - Strike Price of Lower Strike Short Call - Net Premium Received + Commissions Paid
  • Maximum Loss = Occurs When Price of Underlying is in between the Strike Prices of the 2 Long Calls

You really have to be careful in choosing what stocks to use the short condor with. Big moving, high-priced stocks that see substantial volatility after earnings are ideal. Here is a list of stocks that I have used this strategy with good results:

  • Salesforce (NYSE:CRM)
  • Priceline (NASDAQ:PCLN)
  • Netflix (NASDAQ:NFLX)
  • Apple (NASDAQ:AAPL)
  • Google (NASDAQ:GOOG)
  • Chipotle Mexican Grill (NYSE:CMG)
  • Intuitive Surgical (NASDAQ:ISRG)
  • Green Mountain Coffee Roasters (NASDAQ:GMCR)
  • Amazon (NASDAQ:AMZN)
  • CF Industries (NYSE:CF)
  • Baidu (NASDAQ:BIDU)
  • MasterCard (NYSE:MA)
  • CME Group (NASDAQ:CME)
  • F5 Networks (F5)
  • Ralph Lauren (NYSE:RL)
  • V,F. Corporation (NYSE:VFC)
  • Wynn Resorts (NASDAQ:WYNN)

You may ask why would you use a "short condor" spread instead of a "straddle" or "strangle" trade? First, you will automatically see a net credit with the "short condor." The straddle and strangle can be very expensive and the necessity to change strike prices may occur. The main advantage the "straddle" and "strangle" provide for a trader is the unlimited profit potential. That is not the case with the "short condor." However, if you are content going into a trade knowing what your profit can be, the "short condor" has many things to like.

Now we can take a look at a hypothetical trade and see how it plays out. Obviously, you can adjust the strike prices and number of contracts. For instructional purposes, let's assume Google is reporting their earnings next week. I will make the trade with (25) contracts for each leg.

  • Buy (25) GOOG Week 4 November 590 Calls
  • Sell (25) GOOG Week 4 November 580 Calls
  • Buy (25) GOOG Week 4 November 610 Calls
  • Sell (25) GOOG Week 4 November 620 Calls

Your trade ticket should look like this:

Entered Trade

Price Cost
Buy 25 GOOG NovWk4 590 Call $17.30 $43,250.00
Sell -25 GOOG NovWk4 580 Call $23.54 ($58,850.00)
Buy 25 GOOG NovWk4 610 Call $6.10 $15,250.00
Sell -25 GOOG NovWk4 620 Call $2.40 ($6,000.00)

Requirements

Cost/Proceeds ($6,350.00)
Option Requirement $25,000.00
Total Requirements $18,650.00
Estimated Commission $125.00

As you can see, the option requirement is quite hefty as $25,000.00. However, I am placing this with 25 contracts for a larger profit potential as a hypothetical trade. The total requirement is $18.650.00, which is also the maximum amount you can lose. Again, you can choose how many contracts you would like to in order to increase or lower your initial upfront cost.

Here's the interesting part, however. For a stock like GOOG that makes very large moves after reporting earnings, the amount it needs to move (up or down) isn't very significant to make a nice profit, as this graph of the profit/loss chart shows:

Current Price: $600.87

Price Profit / Loss
435.00 $6,350.00
500.25 $6,350.00
568.94 $6,350.00
580.00 $6,350.00
582.54 $0.00
590.00 ($18,650.00)
610.00 ($18,650.00)
617.46 $0.00
620.00 $6,350.00
637.63 $6,350.00
775.00 $6,350.00

With a total risk of $18,650.00 at stake, minus commission costs, a $6.350.00 profit can be attained, which is about 33%. GOOG would really have to trade with little movement for you not to make money on this trade, which rarely happens. The break-even point is $582.54.

For practical purposes, let's take a look at another hypothetical trade for next week with the assumption that earnings are being released soon. Here, we will look at a stock that trades for far less than GOOG, WYNN Resorts WYNN:

  • Buy (25) WYNN Week 4 November 115 Calls
  • Sell (25) WYNN Week 4 November 110 Calls
  • Buy (25) WYNN Week 4 November 125 Calls
  • Sell (25) WYNN Week 4 November 130 Calls

Again, this is how your trade ticket should look:

Entered Trade

Price Cost
Buy 25 WYNN NovWk4 115 Call $7.50 $18,750.00
Sell -25 WYNN NovWk4 110 Call $11.30 ($28,250.00)
Buy 25 WYNN NovWk4 125 Call $1.75 $4,375.00
Sell -25 WYNN NovWk4 130 Call $0.50 ($1,250.00)

Requirements

Cost/Proceeds ($6,375.00)
Option Requirement $12,500.00
Total Requirements $6,125.00
Estimated Commission $125.00

For WYNN, we have a total option requirement of $12,500.00, minus commission costs, which is half of Google's requirement for the same number of contracts. This trade 25 contracts on each leg, but you can choose any amount you would like to enter with.

Here is the profit/loss chart for WYNN:

Current Price $120.78

Price Profit / Loss
82.50 $6,375.00
97.85 $6,375.00
110.00 $6,375.00
112.55 $0.00
114.02 ($3,662.50)
115.00 ($6,125.00)
125.00 ($6,125.00)
127.45 $0.00
130.00 $6,375.00
130.18 $6,375.00
162.50 $6,375.00

On this trade, the maximum loss is $6,125.00. The maximum gain is the net credit received when placing the trade, $6,375.00. Not a bad deal. The break-even price is $112.55. Of course, WYNN would have to move more than GOOG on a percentage basis to profit on the trade.

In summary, if you are confident a stock will make a significant move in the near-term, especially around earnings, the "short condor" is an excellent trade to start using if you do not mind having your total gains capped and still reap large profits. In many respects, it is not as emotional of a trade as others around earnings because you know where the stock has to move to from the start.

In the future, I will write articles based off this strategy for stocks I feel will work very well.

Good luck.

Disclosure: I am long AAPL, CF, CRM. I own long calls on AAPL and CF, in addition to trading them daily, along with ISRG, CMG F5, at various times.

Source: Using The 'Short Condor' Option Spread Around Earnings With Volatile Stocks