Butterflies & Condors

In the last couple posts I talked about vertical spreads in the SPY. A Butterfly or a Condor is a combination of bullish and bearish vertical spreads. There are many variations –

An out of the money bullish position composed of all calls is a “call fly”

An out of the money bearish position composed of all puts is a “put fly”

An at the money neutral position composed of calls & puts is an “iron butterfly”

A butterfly with different but close together short strikes is a “split strike butterfly”

Any of the above with a large distance between short strikes is a “condor” – call condor, put condor & iron condor.

Any of the above with more verticals on one side than the other is the “ratio” version. For example a put fly with 3 long verticals and 2 short verticals is a “ratio put fly”.

Any of the above with one side composed of wider verticals is the “broken wing” version. For example a call condor with a 1 strike wide bullish spread and a 2 strike wide bearish spread is a “broken wing call condor”.

I don’t like any at the money neutral spreads, they take longer to make money & it’s hard to predict that a market will stay range-bound long enough to profit. So all of the “wing spreads” that I trade are out of the money. If you expect a market will move a significant but not great distance & then consolidate for at least several days then a winged spread can work well. The farther you can go out of the money the better they behave, provided that your price assumption is correct.

On the surface a wing spread is a short Vega position. Meaning that if the demand for options increases the position will suffer so that it would seem to be a bad fit for a bearish index market assumption – but in truth an out of the money wing spread will do well regardless of implied volatility as long as it’s a decent distance out of the money initially and the short strikes aren’t too far apart.

In my next post I’ll illustrated these ideas with a few examples.