The Short Albatross Spread is a complex options trading strategy. The components of the strategy make it viable to use in a volatile market when an investor expects a sharp movement in the price of a security.
About Short Albatross Spread
The complexity of the strategy arises from the fact that it involves four separate transactions. These can be a combination of calls and puts but they still remain a challenge for a beginner when combined. This is why it is not ideal for a new investor in the league of the options market.
It is worthy to note that the trade creates an upfront credit spread at the time when the investor takes a position with four separate trades. Sometimes, the strategy is given the name ‘short wide condor spread’ owing to the transactions involved in it.
Some investors consider the short albatross spread as an equivalent of the short condor spread strategy. However, there is one notable difference between the two.
The short albatross strategy uses a wider difference between the strike prices of the underlying security. So, it may be convenient for many traders to just say that the short albatross strategy isn’t a separate strategy on its own.
However, the strategy merits individual discussion since it is commonly used, even if by name.
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When should an investor use the Short Albatross Spread?
The short albatross strategy is an options strategy and benefits an investor if they use it in a volatile market. So when a stock breaks out on its price track, either on the upside or downside, the strategy will work to reap gains for the investor.
Due to the wider difference between the strike prices of the security, the price on the date of expiry will need to move by a significant margin to achieve the gains anticipated by the investor. This is why the potential to make a profit is higher with the short albatross strategy.
The strategy belongs to a family of advanced options trading strategies. The name ‘albatross’ derives itself from the name of a bird, which increases and widens its wingspan.
The best time to employ the strategy is when the investor expects the price of an underlying security to move by a wide margin either on the upside or on the downside.
How to use a Short Albatross Spread in a volatile market?
To make gains from a short albatross strategy, a trader can either place bets on call options or put options.
If they make use of only call options, then the strategy is called a ‘call short albatross spread’. Else, they may use only put options and then the strategy is called ‘put short albatross spread’.
The performance of both strategies is the same as long as the security breaks out either up or down at the date of expiry. The following transactions will be used to create the strategy:
- Sell an in the money option
- Buy an in the money option
- Buy an out of the money option
- Sell one out of the money option
The choice of strike prices depends on the expectation of the investor. So, if they believe that the price of the security will move by a certain margin, they will choose a strike price which is near the price of their expectation.
With the use of more strike prices, the net credit that the strategy opens up could go down to zero. This will also result in an increase in the value of net profit but that will also increase the risk of the strategy.
This is because the actual price of the security will have to go farther out to meet the strike price on the date of expiry.
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What is the potential to earn a profit or incur a loss in Short Albatross Spread?
The upside of the profit which can accrue to the investor on expiry of positions is capped and so is the risk to incur a loss at the end of the strategy.
The maximum profit will accrue to the investor equivalent to the amount of net credit from taking the relevant positions.
In order to make this happen, the price of the security must escape its upper or lower break even point on the date of expiry.
How to implement a Short Albatross Spread?
Let us take an example to understand how the short albatross strategy works. Let us assume that the cost of a stock is INR 50.
You purchase the following contracts, expecting that the stock price will move significantly.
- Write 100 options at a strike price of INR 45 for a cost of INR 4 each.
- Buy 100 options at a strike price of INR 47 for a cost of INR 2.50 each.
- Write 100 options at a strike price of INR 55 for a cost of INR 0.5 each.
- Buy 100 options at a strike price of INR 53 for a cost of INR 1.5 each.
As a result, the investor will spend a total amount of INR 400 and receive an amount of INR 450. So the net credit spread at the beginning of the strategy will be INR 50.
Now, on the date of expiry, the following changes in the price of the security could take place.
- The price of the security could remain at INR 50. Hence, the options in contract 1 above would be worth INR 5 each. Thus, the liability will stand at INR 500. The options in contract 2 above will be worth INR 3 each for a total value of 300. The options in contract 3 and 4 will still expire and become worthless. The liability of INR 500 will be offset by the amount accrued and adjusted for the net credit spread. Hence, the total loss will be INR 150.
- Similarly, the price of security could also go up and down. Accordingly, the investor stands to make a maximum profit which is equal to the amount of net credit amount.
The advantage of short albatross spread lies in the fact that the investor can easily predict the amount of profit and loss over the span of the strategy.
The presence of volatility makes it possible to earn a large potential profit, which is the maximum among the most volatile options strategies. Also, as compared to other options strategies, the incidence of making a loss is small.
However, the strategy also comes with a fair share of disadvantages. Due to four separate transactions involved in this strategy, the commissions of the broker are high.
Also, since credit spread forms at the beginning of the strategy, an investor will need a margin to create and enter the strategy.
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To Conclude Short Albatross Spread
The sheer complexity of this strategy is a deterrent for beginners to try their hand at this strategy.
A lot of time and knowledge goes into planning and executing this strategy and deciding the strike prices at which the trade will be concluded.
With the right expertise and knowledge, a trader can still apply this strategy and expect to make a reasonable gain out of it.
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