A Note On Investment Strategies Involving Options

INVESTMENT STRATEGIES INVOLVING OPTIONS Contd..

Condor Spread

A condor spread trading strategy involves the use of four options with the same expiration date. A condor spread is similar to a butterfly spread, the only difference being that unlike the latter, all the four options in it have different exercise prices. To create a condor spread two options are to be bought at the extreme exercise prices and two are sold at two different halfway prices. Both the upside potential and the downside risk in this strategy are limited.

Example:

A buys two March call options on shares of Andhra Bank, one at a premium of Rs. 8 per share with a strike price of Rs.40 (X1) and the other at a premium of Rs. 2 per share with a strike price of Rs. 74 (X4). A also sells two March call options one at a premium of Rs. 5 per share with a strike price of Rs. 50 (X2) and the other at a premium of Rs. 3 per share with a strike price of Rs. 64 (X3). The payoff table (Refer Table 9) of a long condor spread will be:

Table 9: Payoff using Condor Spread

S	X1	X2	X3	X4	C	Payoff	Net Profit
36	40	50	64	74	2	0	-2
40	40	50	64	74	2	0	-2
44	40	50	64	74	2	4	2
48	40	50	64	74	2	8	6
50	40	50	64	74	2	10	8
54	40	50	64	74	2	10	8
58	40	50	64	74	2	10	8
62	40	50	64	74	2	10	8
64	40	50	64	74	2	10	8
68	40	50	64	74	2	6	4
72	40	50	64	74	2	2	0
74	40	50	64	74	2	0	-2
78	40	50	64	74	2	0	-2

In a calendar spread, options have the same exercise price but different expiration dates. A long calendar spread can be created by using call or put options. In this case, an investor buys a call or put option with a long-term maturity with a certain exercise price and sells a short-term maturity call or put option at the same exercise price. A long calendar spread requires an initial investment, as longer the term of maturity of an option, the more valuable it is. A calendar spread is so designed to take advantage of the time decay, wherein the option closer to maturity loses its value at a much greater rate as it approaches the expiration date than the option with a longer term to maturity. This is because options closer to maturity are more volatile than an option with a long term for maturity. A short calendar spread also known as the reverse calendar spread is the opposite of the long calendar spread. Here, an investor buys a short maturity option and sells a long maturity option.