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Understanding the stock market is quite a challenging task. It is all the more difficult to predict the direction of price movements and formulate strategies accordingly. Despite multiple tools and techniques, some traders fail to predict the market accurately and end up in losses. An indecisive market is the primary reason behind this.
While it is easy to forecast the market movement when there is a dominant trend, it is difficult to do so when there is no prevailing trend. When the market is indecisive, the movement of prices in both directions – upward and downward, is equally probable. In such cases, strategies like the long call condor are helpful. In today’s article, we will understand thoroughly how the long call condor strategy works.
What is a long-call condor?
A long-call condor is a multi-leg options trading strategy with four options contracts. A trader using the long-call condor enters into four contracts to buy and sell call options at different strike prices, expiring on the same day.
This strategy is specifically suitable for a trader who has a neutral outlook on the market and wants to be covered irrespective of the stock’s movement in either way. The trader usually expects the price to move within a specific range and decides the strike price of each option contract accordingly.
Understanding the components of a long-call condor
- Call options: These are options contracts authorising the option holder to buy the security at a preset rate in the future.
- Strike price: The preset price in the options contract at which the holder of the option will buy the asset.
- Expiration date: The date until when the options holder’s right to buy the asset remains active.
- In-the-money (ITM) call options: ITM = Market price or spot price > Strike price.
With an ITM the holder can exercise the contract to purchase the security at a lower price. - Out-the-money (OTM) call options: OTM = Strike price > Spot price.
Hence, the trader cancels the contract since it is worthless.
How does a long-call condor option strategy work?
A long-call condor uses four call options to form a multi-leg order.
- Buy an ITM call option
- Sell an ITM call option at a higher strike price
- Sell an OTM call option
- Buy an OTM call option at a higher strike price
The contracts are strategised in a way where the overall premium is a net debit, helping the traders make some profit irrespective of the market movement.
The long call condor is a limited risk, limited profit strategy. A trader can earn the highest profits if the market price during expiration is between the strike prices of the two sell options. The maximum loss that a trader makes in a long-call condor is limited to the premium paid while buying the two call options.
Example of long condor using calls
Take the example of Stock XYZ, currently trading at ₹50 in the market. Since you are unsure about the direction, you decide to use a long-call condor.
Following are the four options contracts that will expire in one month:
- Buy a call option at ₹40 (ITM) with a premium of ₹65
- Sell a call option at ₹45 with a premium of ₹55 (ITM with a higher strike price than the above)
- Sell a call option at ₹55 with a premium of ₹90 (OTM)
- Buy a call option at ₹60 with a premium of ₹75 (OTM with a higher strike price than the above)
Your total profit from the premium will be: -65+55+90-75 = ₹5 per unit.
- Now, let’s say the stock price goes down to ₹38. All the options become useless since the stock is available to buy at a lower price in the market. So, the entire premium of ₹5 is a loss.
- The stock price reaches ₹60:
Option 1: Will be exercised to earn a profit of ₹20 (60-40)
Option 2: Will be exercised at a loss of ₹15 (45-60)
Option 3: Will be exercised at a loss of ₹5 (55-60)
Option 4: Will expire worthless
So, the net profit is ₹20-₹15-₹5 = ₹0, besides the premium.
- The stock price remains at ₹50:
Option 1: Will be exercised to earn a profit of ₹10 (50-40)
Option 2: Will be exercised at a loss of ₹5 (45-50)
Option 3: Will expire worthless
Option 4: Will expire worthless
So, the net profit is ₹5 (10-5), besides the premium.
Hence, this strategy makes the best profits when the market price is between the strike price of the two sell options.
Bottomline
A long call condor is a multi-leg options strategy, with four call options placed simultaneously. These options are bought and sold at different strike prices, with the same expiry date, to limit the losses irrespective of the market’s direction.
A long call condor is ideal when a trader is unsure about the direction, but predicts the price movement to be within a certain range.
FAQs
Similar to a long-call condor, a long-put condor uses four put options at different strike prices, expiring on the same day. It is also a neutral strategy with limited risk and limited profits.
A short condor is suggested when the market is expected to be very volatile. While a long condor is a net debit strategy, a short condor is a net credit strategy.
The primary risk of long-call options is the contract expiring worthless when the market price is lower than the strike price, because of which the premium paid is lost.
A multi-leg order is an options strategy with multiple contracts. The objective here is to place different contracts expiring simultaneously, to attain the desired profit.
An ATM call option is where the strike price and the spot price, i.e., the market price on the date of expiry are almost equal. So, the strike price – spot price = 0.
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