Directional Condors

So far, all the structures we've looked at have had an outlook as to volatility but not necessarily direction. We bought a condor if we thought the underlying wasn't going to be volatile and would be between the middle strike prices at expiration. Or, we sold a condor if we thought the underlying was going to be very volatile and get below the lowest strike price or above the highest strike price. We didn't care about direction as long as it went far enough in whichever direction it finally picked.

The same was true with iron condors. We either wanted the underlying to sit or move and if it moved, we didn't care in which direction.

What if we had a point of view on direction? We might buy a vertical spread. In doing so, we'll have gotten exposure in the desired direction while reducing the cost of simply buying an option outright. But we've already seen how we might replace an option with a vertical spread, what if we replaced both of the options in a vertical spread with vertical spreads. We'd have a directional condor and we'd probably have it pretty cheaply. Figure 12.10 shows some options in Netflix (NFLX) that we might use to create a directional condor if we were bullish NLFX.

Buying a Directional Call Condor in NFLX

FIGURE 12.10 Buying a Directional Call Condor in NFLX

We pay a net of 6.40 for buying the 450/465 call spread, but we collect a net of 5.00 for selling the 480/495 call spread. Our net outlay is just 1.40, but if NFLX is above 465.00 and below 480.00 at the option expiration, our directional condor will be worth 15.00 (450.00 — 465.00). We will have turned our 1.40 into 15.00 for a profit of 13.60. You can see the payoff chart in Figure 12.11.

A Directional Call Condor in NFLX

FIGURE 12.11 A Directional Call Condor in NFLX

TABLE 12.7 Important Levels and Likelihoods for Our Directional Condor

Describe Move

Price

Likelihood (Delta)

Move upward enough to avoid max loss

450.00

53%

Move upward enough to reach lower breakeven

451.40

52%

Move upward enough to realize max profit

465.00

48%

Move upward enough to begin surrendering max profit

480.00

43%

Move upward enough to reach upper breakeven

493.60

39%

Move upward enough to fully surrender value and realize max loss

495.00

38%

NFLX was at 443.00 when this condor was priced so all the options were out-of-the-money. Unless NFLX rallies to the lower strike price, 450 in this case, we'll lose the entire 1.40. If NFLX rallies too much and is above the 495 strike at expiration, we'll lose the entire 1.40 as well. But there's a pretty big sweet spot, 465.00 to 480.00, where we'll make the maximum profit and an even wider sweet spot, 451.40 to 493.60, where this condor will generate a profit even if the profit isn't the maximum potential profit. What are the likelihoods of these outcomes? We see that in Table 12.7.

The likelihood of NFLX being between 465.00 and 480.00 at option expiration is just 5 percent (48 percent minus 43 percent) and the likelihood of generating any profit is just 13 percent (52 percent minus 39 percent), so the odds of turning our 1.40 to 15.00 are pretty remote. But that's what we'd expect. It's never going to be easy to generate a 1,000 percent profit.

A directional condor is just that, a directional trade. You wouldn't execute this call condor in NFLX unless you expected NFLX to rally gently until December expiration. And since all the legs are out-of-the-money, the bid/ask spread should be less of an issue than it would be for a traditional condor with one of the constituent spreads in-the-money, but you're still executing four different legs, so execution will be important to the ultimate profitability.

Call Condor Cheat Sheet

Long Call Condor

Short Call Condor

Description

Long ITM call vertical spread

Short OTM call vertical spread

Short ITM call vertical spread

Long OTM call vertical spread

Example

Long One 90 strike call

Short One 95 strike call

Short One 105 strike call

Long One 110 strike call

Short one 90 strike call

Long one 95 strike call

Long one 105 strike call

Short one 110 strike call

Pay or Collect Premium

Pay

Collect

Needed Directionality

Passage of Time without Market Movement

+ +

– –

Increase in Implied Volatility without Market Movement

+

Payoff Thumbnail Chart

Maximum Risk

Net premium paid

Width of ITM spread — Premium received for selling ITM spread + Premium paid for OTM spread

Maximum Profit

Width of ITM spread — Cost of ITM spread + Premium received for OTM spread

Net premium received

Breakeven Points

Second lowest strike — Max profit Second highest strike + Max profit

Second lowest strike — Net premium received, second highest strike + Net premium received

Put Condor Cheat Sheet

Long Put Condor

Short Put Condor

Description

Long ITM put vertical spread

Short OTM put vertical spread

Short ITM call vertical spread

Long OTM call vertical spread

Example

Long one 110 strike put

Short one 105 strike put

Short one 95 strike put

Long one 90 strike put

Short one 110 strike put

Long one 105 strike put

Long one 95 strike put

Short one 90 strike put

Pay or Collect Premium

Pay

Collect

Needed Directionality

Passage of Time without Market Movement

+ +

– –

Increase in Implied Volatility without Market Movement

+

Payoff Thumbnail Chart

Maximum Risk

Net premium paid

Width of ITM spread — Premium received for selling ITM spread + Premium paid for OTM spread

Maximum Profit

Width of ITM spread — Cost of ITM spread + Premium received for OTM spread

Net premium received

Breakeven Points

Second highest strike — Max profit

Second lowest strike + Max profit

Second highest strike — Net premium received, second lowest strike plus net premium received

Iron Condor Cheat Sheet

Long Iron Condor

Short Iron Condor

Description

Long OTM call vertical spread

Long OTM put vertical spread

Short OTM call vertical spread

Short OTM put vertical spread

Example

Long one 105 strike call

Short one 110 strike call

Long one 95 strike put

Short one 90 strike put

Short one 105 strike call

Long one 110 strike call

Short one 95 strike put

Long one 90 strike put

Pay or Collect Premium

Pay

Collect

Needed Directionality

Passage of Time without Market Movement

– –

+ +

Increase in Implied Volatility without Market Movement

+

Payoff Thumbnail Chart

Maximum Risk

Net premium paid

Width of one spread minus net premium received

Maximum Profit

Width of one spread minus net premium paid

Net premium received

Breakeven Points

Lower call strike plus net premium paid, higher put strike plus net premium paid

Lower call strike plus net premium received, higher put strike plus net premium received

 
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