Butterflies and Condors


Butterflies and Condors spreads provide known and fixed maximum gain and loss.

They are usually used in cases of high implied volatility and expectations of range-bound underlyings.

They can be implemented using puts or calls.

Condors have a wider range of profit, but cost more.

They take advantage of high implied volatility (seen as likely to fall) and time decay.

Because they require three or four strikes, they are expensive in terms of commissions and/or contract fees.

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  • Be able to profit from range-bound markets?
  • Take advantage of the high option premiums?

Butterflies and Condors are trades intended to take advantage of a neutral outlook and/or high implied volatility. They involve buying two options, at a net debit, to establish a position which profits if the underlying stays within a given range.

The maximum risk and reward are known from the outset of the trade. The risk is equal to the debit paid for the trade and is incurred if the underlying moves too far in either direction. Although these strategies are considered more advanced because of the more complex construction - essentially they combine two vertical spreads, one being a credit spread and the other a debit spread - butterflies and condors have lower risk than call and put selling.

What are Butterflies and Condors?

Butterfly and Condor spreads can be done with calls or puts. Long butterflies using calls involve three strikes: you sell two calls at a middle strike and buy one call above and one call below that strike. Thus, you are combining a vertical bull call spread and a bear call spread with the short calls at the same strike.

Condors also combine a bull call spread with a bear call spread, but separate the sold calls by at least one increment. Condors have a wider range of profit, but cost more. Both spreads are done for a debit.

For example, a MSFT butterfly would entail buying a 27 call, selling two 28 calls, and buying a 29 call. A MSFT condor would involve buying a 26 call, selling a 27 call, selling a 28 call, and buying a 29 call.

Butterflies and condors profit in a limited range around the strikes of the options sold. The trade can be set up with a bullish, bearish, or neutral bias. The spread profits from a fall in implied volatility before expiration. Time decay is on your side, and increases profit. The greatest profit will come if at expiration the underlying is at the butterfly's short strike price, or anywhere between the two short strikes used for the condor.

These spreads lose if the underlying moves too far in either direction. The maximum loss is the debit paid, and is incurred if the underlying moves beyond the strike of either of the long calls.

As an example, with the stock at 27.65, a trader could establish a butterfly by purchasing the a June 27 call and a June 29 call, while selling two June 28 calls, all for a net debit of $.25, which is the maximum risk. The maximum gain at expiration is $.75, if the price is right at 28.

Butterfly trade

Example of a Winning Butterfly Trade

  • Let's say the above butterfly payoff diagram was bought for a net debit of $25:
  • If Microsoft (MSFT) is 27.64 at expiration (that is, unchanged), the profit would be $401.50.
  • If MSFT is at 28.75 or 27.25, the profit would be $0. These are the break-even points.
  • The maximum risk is the $250 we paid, and would be realized if the stock is above 29 or below 27.

Example of a Losing Condor Trade

  • Now let's say we have bought the 26 call, sold the 27, sold the 28, and bought the 29 for a net debit of $.45.
  • If MSFT is between 27 and 28 at expiration, the maximum profit of $55 will be realized.
  • If MSFT is at 26.45 or 28.55, then the profit is $0 (break even).
  • The maximum risk is the $45 paid, realized if the stock is above 29 or below 26.

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