Commodity Options- Condor Spreads

Options are amazing investing and trading tools. While one can use options to position for a move up or a move down in the price of a commodity or any asset, options also have other purposes. Since the chief determinant of the price of an option is implied volatility, call and put option prices respond to changes in market volatility as well as price. Spreading options is the process of trading one or more options against others.

Option spreads are often volatility spreads. They are a bet on increasing or decreasing volatility. Long option spreads generally have limited risk while short option spreads have unlimited potential losses. One spread that option traders often use it the condor spread.

The long condor spread is a limited risk spread structured to take advantage of a market that is perceived to have little or no volatility.

Unlike a butterfly spread, there are four strike prices involved in a condor spread. This type of spread can be constructed using either call or put options. For the purposes of this piece, a long call condor spread will be described.

The buyer of a long condor will sell one in-the-money call option and buy another in-the-money call option with a lower strike price. At the same time an out-of-the-money call option is sold and another out-of-the-money call option with a higher strike price is purchased.

All of the options are on the same commodity, or asset and all are for the same expiration date.

There are four different options transacted in the long call condor (or put condor) and a net debit is paid for the spread. The maximum profit for a long condor is limited and it occurs when the price of the commodity or asset falls between the two middle strike prices at expiration.

The formula for the maximum profit for a long call condor is as follows:

Maximum Profit= Strike Price of the Lower Strike Short Call – Strike Price of the Lower Strike Long Call – Net Premium Paid – Commissions for the entire trade

Maximum Profit occurs when the price of the underlying commodity or asset is in between the strike prices of the two short call options at expiration

Since the long condor is a bet that volatility will be low, if a market moves outside of the range of all options then the maximum loss will occur. At all times, the risk of loss on a long condor is equal to the total premium paid for the position.

Maximum Loss= Net premium paid + commissions for the entire trade

Maximum Loss occurs when the price of the underlying commodity or asset is less than or equal to the strike price of the lower strike price long call option OR greater than or equal to the strike price of the higher strike price long call at expiration

In all option spreads it is important to understand the exact levels where profits and losses occur, therefore breakeven prices are an important factor to monitor. In the case of a long condor call option position there are two breakeven points:

Upper breakeven point= Strike price of the highest strike price long call option – net premium paid

Lower breakeven point= Strike price of the lowest strike price long call option + net premium paid

In both cases, to calculate the exact breakeven point commissions paid must be considered.

While the long call or put condor is a debit spread, a short call or put condor trade results in a credit. The seller of these condors position for a move outside of the range and the economics are exactly opposite from those of the long position. Execution of a condor trade in the options market can be achieved simultaneously, as a spread, or separately. In the case of a separate execution of the strategy, the trader “legs into the spread”. This is generally done in order to achieve a more attractive level for the positions; however “legging” entails more risk. In all cases, commissions are an important part of the trade as each spread contains four separate option positions.

Condor option spreads are popular forms of volatility trades for professional traders that run big option books with many positions. The successful execution of a condor position depends on liquidity in the options market for a particular commodity or asset. Therefore, in the world of commodities, highly liquid futures markets like gold, oil, corn and others are better suited for these types of positions than markets with less liquidity like frozen concentrated orange juice, lumber or others that have less daily volume and interest.