Butterflies & Condors

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Butterfly and Condor Option Spreads

Like other types of options spreads, butterflies and condors are used to profit from either a directionless market or one that is expected to move sharply upward or downward, but without knowing which direction, such as after an earnings report. One advantage of butterflies and condors over straddles or strangles is that profits can be made from a nondirectional market with limited risk. Butterfly and condor option spreads consists of 4 options spread across several strike prices. Each leg of the spread consists of an equal number of contracts. The best reward/risk profile is usually obtained by selecting the center strike prices that are closest to the market price of the underlying security.

Important Note: I strive to keep all the articles on my website up to date, but I continue to use older examples if they continue to illustrate current principles or law. Using newer dates in these examples will not improve their illustrative value, but it would increase the amount of work that I would continually have to do. I update everything that is important, but these option examples are based on timeless principles, so no pedagogical value would be added by using newer dates.

Butterflies

A butterfly spread consists of either all calls or all puts at 3 consecutive strike prices. The 2 intermediate options share the same strike price, and have a position, either short or long, that is opposite of the outer strikes. The butterfly (aka fly) spread takes its name from the shape of the graph, where the 2 inner options are considered the body of the butterfly while the outer options are considered its wings. A butterfly can also be viewed as 2 adjacent vertical spreads where the intermediate options share the same strike price. Likewise, a butterfly can also be viewed as a short straddle bounded by a long strangle, or vice versa.

The long butterfly profits from either a bear or a bull market while the short butterfly profits from a directionless market, one that meanders sideways.

The use of calls and puts in a butterfly has the same profit/risk profile. Therefore, the selection of which type of spread to use will depend on the current market prices of the options. Once the strategy and strike prices are determined, then the trader should choose the options requiring the smallest payment for a long position since the debit will be the maximum possible loss, or one that yields the greatest credit for the short position, since the credit is the short trader’s maximum profit.

Whether the butterfly is a long or short position is reflected in the position of the outer options: if the trader is long in the outer options and short on the inner options, then it is a long butterfly; otherwise, it is a short butterfly. Generally, a short butterfly is undertaken when the underlying security has clear support and resistance levels, which strongly indicates that the underlying security will be range bound.

Long Butterfly

A long butterfly is established, as they say, by buying the wings and selling the body. With a long call butterfly, the long lower call is generally in the money, which is offset by the cost of the 2 middle calls, which are sold. To limit upside risk from the 2 short options, another long call is bought at a higher strike. With a long put butterfly, the highest strike put is generally in the money, while the lowest strike put is bought to offset the risk of the inner short puts.

A bullish or bearish strategy can be obtained by selecting strike prices that are more bullish or bearish respectively. The maximum profit is earned when the stock price is equal to the inner strike price at expiration. If the stock price is lower than the inner strikes, then the long lower call will either earn less or nothing; if the stock price is higher, then the short inner calls will lower the profit earned by the long call until the price equals the highest strike. Thereafter, the 2 short calls offset the 2 long calls. (Note: for the following discussion, K1, K2, K3, and K4 denote successive strike prices, from lowest to highest.)

  • Maximum Profit: K2 – K1 – Debit
  • Maximum Loss: Debit
  • Breakeven Points: K1 + Debit; K3 – Debit
Long Call Butterfly Profit/Loss
Stock Price Profit/Loss
S Example: Long Call Butterfly for Microsoft Established on July 15, 2020
Stock Price $42.45
Long Call Butterfly
September, 2020 Calls Strike Price
1 Long K1 40 -$2.76
2 Short K2 42 $1.42
1 Long K3 44 -0.63
Total Debit – $0.55
Maximum Loss – $0.55
Maximum Profit $1.45
Line chart showing the potential profit/loss of a long call butterfly option spread for Microsoft at options expiration for underlying stock prices of $39 to $45. Because 1 option contract covers 100 shares, each spread can earn a maximum of $145 minus the transaction costs for the 4 contracts composing each spread; the maximum loss is – ($55 + transaction costs).

Short Butterfly

The short butterfly profits when the underlying stock price is expected to be either lower than the bottom strike or higher than the top strike and is established by selling the 2 outer options and buying the 2 inner options. The maximum profit is equal to the credit received for establishing the short butterfly.

Short Call Butterfly Profit/Loss

To take advantage of a large expected price change in the underlying; it may be better to use either a long straddle or a long strangle, where profits are unlimited but losses are limited to the cost of the options. For both the butterfly and the condor when using the same strike prices for both long and short position, the maximum profit of the long position equals the maximum loss of the short position, and vice versa.

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A butterfly can also be constructed with puts:

Stock Price Profit/Loss
S Example: Long and Short Call Butterflies for Facebook Established on July 31, 2020
Stock Price $73.06
Long Call Butterfly
October, 2020 Calls Strike Price
1 Long K1 70 -$6.15
2 Short K2 72.5 $9.70
1 Long K3 75 -$3.70
Debit $0.15
Maximum Loss $0.15
Maximum Profit $2.35
Line chart showing the potential profit/loss of a long call butterfly option spread for Facebook at options expiration for underlying stock prices ranging from $69.50 to $75.50.
Short Call Butterfly
October, 2020 Calls Strike Price
1 Short K1 70 $6.15
2 Long K2 72.5 -$9.70
1 Short K3 75 $3.70
Credit $0.15
Maximum Profit $0.15 = Credit
Maximum Loss $2.35
Lower Breakeven Stock Price $70.15 = K1 + Credit
Upper Breakeven Stock Price $74.85 = K3 – Credit
Line chart showing the potential profit/loss of a short call butterfly option spread for Facebook at options expiration for underlying stock prices ranging from $69.50 to $75.50. ” src=”https://thismatter.com/money/options/images/fb-short-call-butterfly.png”>
Example: Long Put Butterfly for Facebook Established on July 31, 2020

Stock Price $73.06
Long Put Butterfly
October, 2020 Puts Strike Price
1 Long K1 70 -$3.10
2 Short K2 72.5 $8.30
1 Long K3 75 -$5.60
Debit $0.40
Maximum Loss $0.40
Maximum Profit $2.10
Line chart showing the potential profit/loss of a long put butterfly option spread for Facebook at options expiration for underlying stock prices ranging from $69.50 to $76.

Condors

The condor option strategy is so-called because it is considered to have wider wings that results from using options with 4 consecutive strikes instead of the 3 used in a butterfly. The condor has wider breakeven points and can remain profitable over a longer range of the underlying stock price. However, the maximum profit will be less than for an equivalent butterfly.

A long condor is a nondirectional market strategy consisting of all calls or all puts, where the 2 inner options are at consecutive strike prices and the lower outer long option is bought at the strike price below the 2 inner that are sold and another long option at the next strike price above those that are sold. If some strike prices are skipped between the inner short options and the outer long options, then this strategy is referred to as a pterodactyl, for its wider wingspan. A long condor can also be thought of as being 2 verticals, a combination of a bull vertical and a bear vertical.

Long Condors

The maximum profit in a long condor is achieved as long as the price of the underlying stays within the 2 short center strikes. The maximum risk is the debit paid to establish the condor.

  1. Maximum Profit = K2 – K1 – Debit
  2. Maximum Risk = Debit
  3. Lower Breakeven Point = K1 + Debit
  4. Upper Breakeven Point = K4 – Debit

Profit is earned when the underlying security closes between the wings at a price from which the difference from either strike exceeds the cost of the spread.

Long Call Condor Profit/Loss

Stock Price Profit/Loss
S ≤ K1 Debit Maximum loss: all calls expire worthless.
K1 Long Call Condor for Facebook
Stock Price $73.06
Date 7/31/2020
October Options Strike Cost
K.1 70.0 -$6.15 Buy 70 Call
K.2 72.5 $4.85 Sell 72.5 Call
K.3 75.0 $3.70 Sell 75 Call
K.4 77.5 -$2.73 Buy 77.5 Call
Debit –$0.33
Maximum Profit $2.17
Maximum Loss $0.33
A line chart showing the value of a long call condor for Facebook as the stock price varies from $68 to $80.
Long Put Condor Profit/Loss
Stock Price Profit/Loss
S ≤ K1 Debit Maximum loss: short puts offset long puts.
K1 Long Put Condor for Facebook
Stock Price $73.06
Date 7/31/2020
October Options Strike Cost
K.1 70.0 -$3.10 Buy
K.2 72.5 $4.15 Sell
K.3 75.0 $5.50 Sell
K.4 77.5 -$8.95 Buy
Debit –$2.40
Maximum Profit $0.10
Maximum Loss $2.40
A line chart showing the value of a long put condor for Facebook as the stock price varies from $68 to $80, using the same strike prices as the long call condor. Obviously, the long call condor is preferable for these strike prices.

Short Condors

A short condor, like the short butterfly, is used when the underlying price is expected to move sharply upward or downward. The maximum risk occurs when the market meanders, without direction.

Short Call Condor Profit/Loss

Stock Price Profit/Loss
S ≤ K1 Credit Maximum profit: all calls expire worthless.
K1 Short Put Condor Profit/Loss
Stock Price Profit/Loss
S ≤ K1 Credit Maximum profit: short puts offset long puts.
K1 Short Put Condor for Facebook
Stock Price $73.06
Date 7/31/2020
October Options Strike Cost
K.1 70.0 $3.10 Sell
K.2 72.5 -$4.15 Buy
K.3 75.0 -$5.50 Buy
K.4 77.5 $8.95 Sell
Credit $2.40
Maximum Profit $2.40
Maximum Loss $0.10
A line chart showing the value of a short put condor for Facebook as the stock price varies from $68 to $80, using the same strike prices as the long call condor. Given the market conditions at the time of the spread, this is the best spread to use if the price of Facebook is expected to move at least $3 upward or downward within the 2½ months till expiration, which is very likely. Although the profit is limited to $2.40, the maximum loss of $.10 is much less than an equivalent long straddle or strangle. Since American option contracts cover 100 shares on the underlying, each spread would earn $240 compared to a possible $10 loss, which is a pretty decent trade-off.

Iron Spreads

An iron butterfly or condor spread is one that uses both puts and calls. The inner options consists of a put and a call, which are either long or short, and the outer options are both a put and a call, either short or long. Technically, a long spread is paid for with a debit, while a short spread yields a credit. In a plain-vanilla long butterfly, the inner options are sold while the outer options are bought, which usually results in a debit because one of the long options is in the money, which increases the cost of the spread. However, in an iron spread, the inner options are usually at the money while the outer options will be out of the money because one is a OTM call and the other is a OTM put. Therefore, a long iron spread — either butterfly or condor — will yield a credit while the short spread will cost a debit. This is opposite to the plain-vanilla spreads.

Most condors have a call spread and put spread of equal width. An iron condor that consists of a call spread with a different width from the put spread is referred to as a broken wing iron condor.

For the short iron condor, a larger premium will be collected if the call and put spreads are closer to one another, but will also have a higher probability of losses, since the breakeven points will be closer.

Long Iron Butterfly and Condor

The long iron butterfly and the long iron condor are established by selling a straddle and buying a strangle that brackets the straddle, using both puts and calls. The strike prices of the 2 inner options are the same for the butterfly, but different for the condor; otherwise, they have a similar reward/risk profile. So a long iron butterfly would have long options for the wings and short options for the body, such as a long put at strike K1, a short put at K2, a short call at K2, and a long call at K3.

The long iron butterfly or condor can also be viewed as a combination of 2 vertical spreads: a bull put credit spread and a bear call credit spread.

Long Iron Butterfly or Condor as a Combination of a Bull and a Bear Credit Vertical Spread

Bull Put Credit Spread + Bear Call Credit Spread
  • Maximum Profit: Credit
  • Maximum Loss: (K3 – K2) or (K2 – K1) – Credit
  • Underlying Price Breakeven Points: K3 + Credit; K2 – Credit
Long Iron Butterfly Profit/Loss
Stock Price Profit/Loss
S ≤ K1 Credit – (K2 – K1) Maximum loss at K1: at lower prices, the short put offsets the long put; calls expire worthless.
K1 Example: Long Iron Butterfly for Facebook
Stock Price $73.06
Date 7/31/2020
October Options Strike Cost
K.1 70.0 -$3.10 Buy 70 Put
K.2 72.5 $4.15 Sell 72.5 Put
K.3 72.5 $4.75 Sell 72.5 Call
K.4 75.0 -$3.70 Buy 75 Call
Credit $2.10
Maximum Profit $2.10
Maximum Loss $0.40
Line chart showing the value of a long iron butterfly for Facebook as the stock price varies from $69 to $76.
Long Iron Condor Profit/Loss
Stock Price Profit/Loss
S ≤ K1 Credit – (K2 – K1) Maximum loss at K1: at lower prices, the short put offsets the long put; calls expire worthless.
K1 Example: Long Iron Condor for Facebook
Stock Price $73.06
Date 7/31/2020
October Options Strike Cost
K.1 70.0 -$3.10 Buy 70 Put
K.2 72.5 $4.15 Sell 72.5 Put
K.3 75.0 $3.65 Sell 72.5 Call
K.4 77.5 -$2.73 Buy 75 Call
Credit $1.97
Maximum Profit $1.97
Maximum Loss $0.53
Line chart showing the value of a long iron condor for Facebook as the stock price varies from $68 to $80. As you can see, the long iron condor has a slightly lower maximum profit ($1.97 versus $2.10) and a slightly higher maximum loss ($.53 versus $.40) than the long iron butterfly using the same strike prices. However, the long iron condor is more likely to be profitable because the maximum profit is earned between 2 consecutive strike prices rather than at a single strike price.

Short Iron Butterfly and Condor

Short Iron Butterfly or Condor as a Combination of a Bull and a Bear Debit Vertical Spread
Bear Put Debit Spread + Bull Call Debit Spread
Short Iron Butterfly Profit/Loss
Stock Price Profit/Loss
S ≤ K1 (K2 – K1) – Debit Maximum loss at K1: at lower prices, the short put offsets the long put; calls expire worthless.
K1 Short Iron Condor Profit/Loss
Stock Price Profit/Loss
S ≤ K1 (K2 – K1) – Debit Maximum profit at K1: at lower prices, the short put offsets the long put; calls expire worthless.
K1 Example: Short Iron Condor for Facebook
Stock Price $73.06
Date 7/31/2020
October Options Strike Cost
K.1 70.0 $3.10 Sell Put
K.2 72.5 -$4.15 Buy Put
K.3 75.0 -$3.65 Buy Call
K.4 77.5 $2.73 Sell Call
Debit -$1.97
Maximum Profit $0.53
Maximum Loss $1.97
Line chart showing the value of a short iron condor for Facebook as the stock price varies from $68 to $80. As you can see, the short iron condor is the inverted image of the long iron condor, with the maximum profit equal to the maximum loss of the other; likewise for the maximum loss.

Choosing Which Spread to Trade

When choosing which spread to trade, the 1 st factor to consider is whether the market is expected to be range bound or whether a large move is expected, but without knowing the direction. If the underlying asset is expected to be range bound, then a long butterfly or condor should be established; otherwise, only short spreads should be considered.

Additionally, commissions should be considered, since they may constitute a larger percentage of potential profits. Some brokers charge a single commission to establish a spread; others will charge each leg of the spread as a separate option transaction, in which case, each condor or butterfly spread would incur 4 transaction costs.

Comparison of the Maximum Profits and Losses for Option Spreads for Facebook

The low for Facebook on the last trading day for October, 2020 options was $73.75 and the high was $76.00, closing at $75.95, so the long spreads were the most profitable.

Long Spread Comparison for a Directionless Market

Spread Maximum Profit Maximum Loss
Long Call Butterfly $2.35 ($0.15)
Long Call Condor $2.17 ($0.33)
Long Put Butterfly $2.10 ($0.40)
Long Iron Butterfly $2.10 ($0.40)
Long Iron Condor $1.97 ($0.53)
Long Put Condor $0.10 ($2.40)
Short Spread Comparison for a Bull or Bear Market
Spread Maximum Profit Maximum Loss
Short Put Condor $2.40 ($0.10)
Short Iron Condor $0.53 ($1.97)
Short Call Butterfly $0.15 ($2.35)

As with other types of spreads, a butterfly or condor spread for a given set of market conditions should be chosen that yields the greatest return with the least risk, which will depend on the market prices of the constituent options, as can be seen in the 2 tables above, sorted from highest to lowest maximum profit, that summarize the worked out examples for Facebook. Out of the worked out examples, for a directionless market, the long call butterfly offers both the maximum profit with the least risk; for either a bull or bear market, the short put condor offers, by far, the highest profit with the least risk.

Butterfly / Condor

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The butterfly consists of being long 1, short 2, long 1 options across different strikes.

The long butterfly can be constructed using either just calls, just puts, or a combination of both. It can also be thought of as being short a call spread and short a put spread.

The butterfly often has equidistant strikes. The call butterfly (and put butterfly) with equidistant strikes will never have a negative payoff, hence this offers a arbitrage opportunity if the price of the butterfly was negative.

The butterfly is often described simply by the strikes. For example, if you are long a 10-20-30 butterfly, you are long 1 option on the 10 strike, short 2 options on the 20 strike, and long 1 option on the 30 strike. The 10-20-30 call fly would thus be long the call option on the 10 strike, short 2 call options on the 20 strike and long 1 call option on the 30 strike.

The strike in the center is known as the “meat”, while the strike at the ends is known as the “wings”.

A skinny fly consists of being long 1, short 1, long 1 option across different strikes.

The condor consists of being long 1, short 1, short 1, long 1 option across 4 different strikes. As before, it is often described simply by the strikes of the option contracts.

Contents

Payoff diagrams

The skinny fly is best understood from a delta-neutral perspective, to understand the effects of the position. As such, the payoff diagram will include some stock trade.

Greeks of position

When the underlying is near to the middle strikes (meat), the long butterfly and condor positions are:
1. Delta neutral (or close to)
2. Short Gamma
3. Collecting Theta
4. Short Vega

Note: The butterfly is unique because it is the (one of the few) option strategies where you are long it, while collecting theta.

Favorable conditions for trade

Consider buying butterflies and condors when
1. You believe that the underlying will trade in a tight range
2. You believe that the underlying will trade in a tight range, or move significantly. In this case, the long wings offer you protection against the move.

Situation 2 could occur when there is no strong reason for a move, but there is a strong reason for a directional move if the underlying starts to move. Examples include an increase in margin requirement which could cause forced liquidation, and overbought / oversold situations. In this case, a skinny fly might work better. Though it is more costly without movement, it pays off handsomely when the move is sudden.

Butterflies & Condors

In the last couple posts I talked about vertical spreads in the SPY. A Butterfly or a Condor is a combination of bullish and bearish vertical spreads. There are many variations –

An out of the money bullish position composed of all calls is a “call fly”

An out of the money bearish position composed of all puts is a “put fly”

An at the money neutral position composed of calls & puts is an “iron butterfly”

A butterfly with different but close together short strikes is a “split strike butterfly”

Any of the above with a large distance between short strikes is a “condor” – call condor, put condor & iron condor.

Any of the above with more verticals on one side than the other is the “ratio” version. For example a put fly with 3 long verticals and 2 short verticals is a “ratio put fly”.

Any of the above with one side composed of wider verticals is the “broken wing” version. For example a call condor with a 1 strike wide bullish spread and a 2 strike wide bearish spread is a “broken wing call condor”.

I don’t like any at the money neutral spreads, they take longer to make money & it’s hard to predict that a market will stay range-bound long enough to profit. So all of the “wing spreads” that I trade are out of the money. If you expect a market will move a significant but not great distance & then consolidate for at least several days then a winged spread can work well. The farther you can go out of the money the better they behave, provided that your price assumption is correct.

On the surface a wing spread is a short Vega position. Meaning that if the demand for options increases the position will suffer so that it would seem to be a bad fit for a bearish index market assumption – but in truth an out of the money wing spread will do well regardless of implied volatility as long as it’s a decent distance out of the money initially and the short strikes aren’t too far apart.

In my next post I’ll illustrated these ideas with a few examples.

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