Butterflies and Condors as Volatility Trades

Butterflies and condors cap both the profit and the loss on a bet that the stock stays inside a defined range through expiry.

A long butterfly and a long condor both bet on the stock staying inside a defined range through expiry, and both cap the maximum loss at the premium paid, which is what separates them from a naked short straddle expressing the same low volatility view with unlimited risk. A butterfly pins its maximum profit to a single strike in the middle, while a condor widens that peak into a flat range between two strikes.

Using calls struck at $95, $100 and $105 on a $102 stock, priced illustratively at $8.50, $5.20 and $2.60, a long butterfly buys one $95 call, sells two $100 calls, and buys one $105 call. The premiums net to negative $8.50 plus $10.40 minus $2.60, a debit of $0.70 paid to put the position on.

At expiry, if the stock finishes exactly at $100, the payoff is $5.00, the width between the $95 and $100 strikes, since the $95 call is worth $5 and both the short $100 calls and the long $105 call are worthless. Against the $0.70 paid, that is a profit of $4.30, the maximum the position can earn. If the stock finishes at or below $95, or at or beyond $105, every leg cancels to zero and the loss is capped at the $0.70 premium paid, the maximum the position can lose.

A condor uses four strikes instead of three. Using calls at $90, $95, $105 and $110 priced illustratively at $13.20, $8.50, $2.60 and $1.05, buying the $90 and $110 calls and selling the $95 and $105 calls costs negative $13.20 plus $8.50 plus $2.60 minus $1.05, a net debit of $3.15.

If the stock finishes anywhere between $95 and $105 at expiry, the payoff is $5.00, the width between the $90 and $95 strikes, for a maximum profit of $1.85 after the $3.15 paid. If the stock finishes at or below $90 or at or beyond $110, every leg cancels and the loss is capped at the $3.15 premium, the maximum the position can lose. The condor trades a lower maximum profit than the butterfly for a wider range in which that profit is achieved, which is the standard tradeoff a trader weighs when choosing between the two structures for a given view on how tightly the stock is likely to stay pinned.