CONDOR OPTION TRADING STRATEGY EXPLAINED -With examples from future option trading
Here I'll explain the condor option trading strategy. As the underlying in the examples we'll use the CME ® Aug-08 lean hogs future.
First thing to note is that a long condor is a bet on a big move in the market, in this case in the price of the underlying future. Vice versa, a short condor is a bet that the market will be quiet. This strategy is thus neutral when it comes to direction. So the condor is a relative of the butterfly, strangle and straddle option trading strategies.
Before explaining further, I suggest you make sure you're familiar with payoff diagrams and how to read option quotes. For definitions of lean hogs futures and options, visit CME®.
So...we expect a major move in the market but are not sure about the direction. At the time of writing we're in the beginning of what might be a collapse in the US housing market. Will this lead to a downturn in the economy or will the storm pass quickly? And how does the answer to that question impact our view of lean hogs futures? Assuming that we don't have a strong opinion on the first question, a directionally neutral future option trading strategy is our choice.
The condor consists of one long put, one long call, one short put and one short call. In this strategy the long options have the same strike price, the short call has a higher strike price than the long options and the short put has a lower strike price than the long options. So to in order of strike price:
Lowest strike price: Short put
Middle strike: Long call and put
Highest strike: Short call
We short the options with the low and high strikes, or the "wings". Thus we forego the profit of accruing from those options at very low and very high prices. Had we not done this, we'd ended up with a straddle. This makes the condor more cautious a strategy than the straddle.
Let's now construct a condor. Back to the CME® options on Aug-08 lean hogs futures. This future has so far traded between 69.5$ and 74$. Looking at other lean hog futures with delivery closer in time, we see that they exhibit a similar trading range. Expecting some resistance/support at these two levels might make you appreciate the profit opportunities in the "wingtips" less. Thus preferring a condor over a straddle.
A by-the-book condor future option position is symmetrical. The closest strikes to 69.5$ and 74$ are the 70$ and 74$. So we go short a put with strike 70$ and short a call with strike 74$. For symmetry we choose 72$ as the strike for our long call and put. All the options expiring in Aug 08.