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To thrive in the ever-changing world of options trading, familiarity with a variety of strategies is essential. The short call condor and the short call butterfly are two strategies that traders often find intriguing. Despite their apparent complexities, these strategies have the potential to provide distinct benefits when implemented properly.
The purpose of this article is to shed light on these tactics by explaining how they work, the advantages they provide, and the main distinctions between them. Regardless of your experience level in trading, this guide is designed to enrich your understanding and application of these strategies.
Understanding options trading
Traders can lock in a price to purchase or sell an asset through options trading, a type of derivative trading. Here are a few important terms:
Call option: An option to purchase an item at a set price and within a set time frame is granted to the option holder in this contract.
Put option: The option holder has the right, but not a responsibility, to sell an item to the vendor within a certain time frame and for a certain price in this type of contract.
Strike price: Option holders can choose to purchase (call options) or sell (put options) the underlying security at this price.
Premium: In exchange for the option (call or put), the option holder pays the option writer this amount as compensation to meet the obligations of the contract.
Underlying asset: This is the underlying financial asset (such as a stock, futures, commodity, currency, or index) that determines the value of a derivative.
Expiration date: The option contract is null and invalid as of this date.
In The Money (ITM): Having intrinsic value is what determines whether an option is deemed ITM. To be in the money (ITM) with a call option, the underlying asset’s market price must be higher than the strike price. Assuming the current market price is lower than the strike price, the put option is deemed “in the money” contingently.
At The Money (ATM): The option is said to be “at the money” when the underlying security’s market price is exactly equal to its strike price.
Out of The Money (OTM): For options that are not in the money, their value is zero. An out-of-the-money call option is one where the underlying price is trading lower than the strike price. When the underlying price goes up over the strike price, put options also become inactive.
Short call butterfly
When traders anticipate high levels of market volatility, they employ the neutral strategy known as the short-call butterfly. An additional Out-of-the-Money (OTM) call option is being sold alongside the two ATM call options that were purchased.
| Type | Strike price |
| Sell | ITM |
| Buy | ATM |
| Sell | OTM |
Both the upper and lower strikes should be equally spaced from the middle strike, and the expiration dates of all options should be identical. With this strategy, there is little space for both success and failure.
Suppose you are observing TATA Motors stock which is currently trading at ₹300. You believe that the price will remain around this level in the near future, but you also want to account for some volatility. Follow these steps to establish a short call butterfly strategy:
- Sell one call option that is In-the-Money (ITM) with a strike price that is slightly lower than ₹300, for example, ₹290.
- Get two ATM call options with a ₹300 strike price.
- Sell one Out-of-the-Money (OTM) call option for ₹310, which is just above ₹300.
It is anticipated that the expiration dates of all these options will be identical. Now, whether the price of Tata Motors stock at expiration is slightly below ₹300 or slightly above ₹300, you stand to make a profit.
Short call condor
If traders anticipate high volatility and a large move in the underlying asset’s price, they can use the neutral short-call condor strategy. It entails selling an in-the-money call option, purchasing an out-of-the-money call at a higher strike, selling an OTM call at the highest strike, and buying another out-of-the-money call at an even higher strike.
| Type | Strike price |
| Sell | ITM |
| Buy | ITM (higher strike) |
| Buy | OTM (even higher strike) |
| Sell | OTM (highest strike) |
A single expiration date is required for all options. Its low-risk, low-reward potential is similar to that of the short call butterfly.
Suppose you’re observing Infosys stock, which is currently trading at ₹1500. You believe that the price will remain around this level in the near future, but you also want to account for some volatility. Follow these steps to establish a short call condor option strategy:
- It is recommended to sell one ITM call option with a strike price slightly below ₹1500, around ₹1450.
- Acquire one ITM call option with a strengthened strike price of ₹1500.
- Purchase a single Out-of-the-Money (OTM) call option with a new, higher strike price of ₹1550.
- It is recommended to sell one call option that is not in the money and has a strike price of ₹1600.
It is anticipated that the expiration dates of all these options will be identical. Now, whether the price of Infosys stock at expiration is slightly below ₹1500 or slightly above ₹1500, you stand to make a profit.
Advantages and Disadvantages of Short Call Butterfly and Short Condor
When trading options, two commonly used strategies for advanced traders are the Short Call Butterfly and the Short Call Condor. Both strategies involve multiple option positions and are typically used when a trader expects low volatility in the market. However, each strategy has its unique features, advantages, and risks. Here’s a comparison to help you understand both.
Short Call Butterfly
The Short Call Butterfly involves selling one call option at a lower strike price, buying two call options at a middle strike price, and selling another call option at a higher strike price. The net result is a strategy that profits if the underlying asset remains close to the middle strike price at expiration.
Advantages of Short Call Butterfly
- Profit Potential in a Range-Bound Market: This strategy profits when the asset price remains near the middle strike price. The maximum loss occurs when the price moves significantly away from the middle strike.
- Lower Cost: Since the strategy involves selling two calls and buying one, the premium received for selling the calls helps offset the cost of the long position, making it relatively inexpensive.
- Defined Risk: The risk in this strategy is known upfront and limited to the difference between the strike prices minus the net premium received. This makes it easier to manage.
Disadvantages of Short Call Butterfly
- Limited Profit Potential: The maximum profit is capped at the middle strike price, meaning that even if the underlying asset moves within the range, the profits are limited.
- Small Profit Range: The strategy requires the underlying asset to stay close to the middle strike price, which limits its effectiveness in a volatile market.
- High Complexity: This strategy can be more complicated to manage than other simpler options strategies, especially when adjusting positions if the market moves unexpectedly.
Short Call Condor
The Short Call Condor is similar to the short call butterfly but involves four different strike prices instead of three. It consists of selling one call at a lower strike, buying one call at a middle lower strike, buying another call at a middle upper strike, and selling a call at a higher strike price. The short call condor also works best when the underlying asset is expected to remain relatively stable.
Advantages of Short Call Condor
- Higher Probability of Profit: With four strike prices, this strategy provides a larger profit zone compared to the short call butterfly. As long as the asset price stays within the two middle strikes, it offers a wider profit window.
- Lower Risk: The short call condor has a wider range between the short calls, which reduces the overall risk compared to the short call butterfly.
- Lower Cost: Like the short call butterfly, this strategy can be relatively inexpensive to implement due to the combination of sold and bought calls, with the premium collected from the short calls reducing the net cost.
Disadvantages of Short Call Condor
- Limited Profit Potential: Even though the strategy has a wider profit range, the maximum potential profit is still capped. The maximum profit comes from the range between the two middle strikes.
- Complexity: The multiple strikes in this strategy make it more complex to manage and adjust, particularly when trying to make decisions about adjusting positions based on market movements.
- Profit Only in Low Volatility: Like the short call butterfly, this strategy performs best in a low volatility market. If the underlying asset experiences significant price movement, the strategy can lead to losses.
Comparison
In unstable markets, you can use either strategy, but the main difference in regards to short call butterfly vs short call condor is in the option strike prices you use.
A short call butterfly’s ATM call purchase is equivalent to a short call condor’s ITM and OTM call purchases. The short call condor has additional leeway given that a broader range of underlying asset prices at expiration is possible.
Although the profit potential is lower, the maximum profit zone, or sweet spot, for condors is significantly wider than that for butterflies.
Bottomline
In the vast landscape of options trading, the short call butterfly and short call condor aren’t merely strategies, they’re gateways – gateways to steer through market fluctuations, amplify gains, and curtail losses. Keep in mind that as you progress through your trading journey, each new strategy you learn is like adding a weapon or tool to your arsenal.
FAQs
The short put butterfly and short call butterfly are both neutral options strategies with limited risk and profit potential. The key difference lies in the type of options used. The short put butterfly uses put options, while the short call butterfly uses call options. Both strategies involve options at 3 strike prices.
A long condor is an options strategy that profits from low volatility and little to no movement in the underlying asset. On the other hand, a short condor seeks to profit from high volatility and a sizable move in the underlying asset in either direction.
Butterfly options can be profitable, especially in low-volatility markets. They offer a fixed risk and capped profit, making them a market-neutral strategy. However, their profitability depends on the underlying asset’s price remaining stable until option expiration. Remember, all trading strategies carry risk and should be used wisely.
When the underlying asset’s price is the same as the short strike options at expiration the maximum profit of a call butterfly strategy is achieved. In this scenario, the short call options expire worthless, and the in-the-money long call option may be sold. The profit is the width of the spread, minus the debit paid.
The four-legged butterfly strategy is a neutral options strategy combining bull and bear spreads. It involves taking positions in four different option contracts with the same expiration but three different strike prices. This strategy can be implemented using either calls or puts.