Wingspreads : Butterflies and Condors
The term “Wingspreads” describes types of options strategy spreads whose Profit and Loss Chart resemble flying animals – the butterfly and the condor.
As you will see from the following charts, they are very similar. Both of these types of strategies require minimal capital although while the risk of loss is limited, so is the profit. Though as similar as they may appear, they are not the same; the main difference being Butterfly spreads utililize three strike prices while Condor spreads use four.
Let’s First Explore Butterfly Spreads
Butterfly spreads combine bull and bear spreads with three different strike prices. These can be made up of four puts, or four calls, or a combination of puts and calls which is known as the Iron Butterfly. The upper and lower strike prices are equal distance from the middle strike price (the ‘at-the-money’ strike price) and all calls have the same expiration date.
Let’s take a look at the various kinds of Butterfly spread strategies.
Long Call Butterfly Spread
For this strategy one call is purchased at a lower strike price, two calls are sold with a higher strike price and one call is bought with an even higher strike price. In butterfly fashion the expiration dates are all the same, as is the distance between strike prices. (Buy/Sell/Sell/Buy)
Long Put Butterfly Spread
For the long put butterfly a single put is purchased with a lower strike price, selling two ‘at-the-money’ puts and purchasing a put that is at a higher strike price. (Buy/Sell/Sell/Buy)
Both the Long Call and Long Put spreads are for when you expectg a stock to remain within a certain price range until expiration. The profit is maximized the closer to the middle of the range the stock price stays in.
There are also two similar strategies for when you expect a stock to move outside of a price range before expiration, these are called Reverse Butterfly spreads.
Short Call Butterfly Spread
A short call butterfly spread is implemented by selling one call at a lower strike price, buying two calls with a higher strike price and selling one call with an even higher strike price. (Sell/Buy/Buy/Sell)
Short Put Butterfly Spread
The short put butterfly is when you sell one put at a higher strike price buy two puts with a lower strike price and sell one put with an even lower strike price. (Sell/Buy/Buy/Sell)
Iron Butterfly Spread
For the Iron butterfly strategy you sell one at-the-money Put, buy one out-of-the-money Put, and sell one at-the-money Call, and buy one out-of-the-money Call. All four options are for the same stock, and the same expiration date just like every other butterfly spread. (Sell/Buy/Sell/Buy)
Reverse Iron Butterfly Spread
This strategy is when you sell an out-of-the-money put at a lower strike price, buy an at-the-money put, buy an at-the-money call, and sell an out-of-the-money call at a higher strike price. (Sell/Buy/Buy/Sell)
Butterfly spreads are most profitable if the underlying asset doesn’t move much before the option expiry date. The reverse spreads are for the opposite and would be used when the stock is expected to move outside of the price range. Remember that the expiration dates are all the same, as is the distance between strike prices in Butterfly strategies.
Condor spreads are very simillar to Butterfly spreads but with one key difference: they are built from four stike prices instead of three. The advantage to Condor spreads over Butterfly spreads is that they remain profitable over a longer stock price spread. The disadvantage is that the maximum profit is reduced as a result. While opening a Condor spread gives you a little more room for stock price movement it is at the cost of a lower potential return.
There are three types of Condor spreads: Long Condor, Short Condor and Iron Condor.
Long Condor Spread
The Long Condor uses four options but they are either all calls or all puts. The strategy consists of buying a call at lowest strike price, selling a call with the second lowest strike price, selling a call with the second highest strike price and buying a call with the highest strike price. (Buy/Sell/Sell/Buy)
Iron Condor Spread
The Iron Condor strategy uses BOTH puts and calls and is essentially as follows: Buy one out-of-the-money put at a lower strike price, sell one ‘at-the-money’ put with a strike price closer to the current price, sell one ‘at-the-money’ call with a second highest strike price and buy one ‘out-of-the-money’ call for the highest strike price. (Buy/Sell/Sell/Buy)
Short Condor Spread
Like the Long Condor, the four options that the Short Condor uses are all calls or all puts. For this strategy you would sell one call at a lower strike price, buy one call with a higher strike price, buy another call with an even higher strike price and sell one more call with an even higher strike price. (Sell/Buy/Buy/Sell)
This strategy would be used when seeking to profit from high volatility and when expecting a large movement in the underlying asset in either direction. Just like the Reverse Butterfly, it doesn’t matter which direction the stock price moves just as long as it moves outside of the range as the maximum profit is outside of the range and the maximum loss is in the middle.
Like in the Butterfly spreads, the options in the Condor spreads have the same expiration date and the strike prices are typically even distances apart, they profit from the same conditions in the underlying asset. The main difference is the maximum profit zone for a condor is much wider than that for a butterfly, and the potential for profit is a little lower.
Which to use when you may ask?
The Butterfly spread is best used in a neutral market and when low volatility is expected, thus allowing opportunity to earn a certain amount of profit and with limited risk. The commissions are a little higher than for Condor spreads but the profit is greater, although it is also capped.
Condor spreads are also ideal in a neutral market, and when volatility is expected to be low or high but the profit (and risk) are low and lower than that of a Butterfly spread.
In review, these low risk spreads have their place in the market, and help to maintain profit in a very conservative manner. They are good to have in place even while you are utilizing or experimenting with other, perhaps more riskier options trading strategies.
I welcome comments and questions always!