Options trading offers a number of benefits to traders, and one of them is the ability to profit and stay protected from Bitcoin price corrections. Whenever BTC seems to be struggling between two levels, traders start fearing that significant Bitcoin price corrections might be on their way. A similar situation occurred during the previous year when Janet Yellen, a secretary of the US Treasury, made a suggestion that terrorism was being financed with the help of cryptocurrencies.
Another factor that fueled the fear during the same period was the BTC's 696% gain. There are two popular and highly useful methods that traders use in such situations to diminish exposure. The first is reducing open position sizes, and the second is using BTC options contracts. The latter is an efficient way of getting protection and the easier of the two as well. However, buying a put option can be costly depending on the volatility scenario.
Let us take a look at an example. Suppose we are standing in the February of last year. A put option with a 26th March expiry and a 56,000 strike trades at 5,300 would get the purchaser a profit only on the condition of BTC trading below 50,700 within a period of 32 days. At the time of buying the option, the price was 57,500, which is 12% higher. This means that the protection cost is dependent on the implied volatility as well as the time remaining until expiry or the expectation of a trader pertaining to substantial price swings.
A huge number of possibilities and opportunities present themselves to traders when they use puts and call options to create different strategies. They can reduce the cost in a significant manner as well. However, in this article, we will take a look at only one of them; a low-cost and bearish one. But first, let us gain a better understanding of crypto options trading.
Understanding Crypto Options Trading
In comparison with perpetual swaps or crypto futures, crypto options usually provide traders with solutions for digital asset trading that are low-risk and low-cost. An option does not put an obligation on its buyer but rather offers them a right to trade an underlying asset before the date of expiry, at a set price. It is simply a kind of a derivative contract. A "put" option is the purchaser's right to sell, while a "call" option is their right to buy the asset.
Options can be settled against Ether, Bitcoin, or any other actual cryptocurrencies as well as against cash (USD). An option is not any different than other derivatives and enables traders of crypto to make speculations on the underlying asset's future price. OKEx, which is the second-largest exchange of crypto options, delivers crypto assets to traders in a physical manner when they exit a trade. This means that the traders receive Bitcoins as profits at the time of settlement. Deribit, which is the largest crypto options platform, on the other hand, settles the contracts against cash.
The process of options trading starts with the seller creating or writing call as well as put options contracts that have the dates of expiry mentioned on each of them. This is the date that the contract must be settled by. The strike price is also mentioned on each contract which is the price at which the buyer of the contract can buy or sell the asset before it expires. The seller of options lists the created contracts on any crypto options platform. A buyer of an option has the option of placing an order on a platform as well, and a seller can then sell into it.
The cost associated with an option is called a premium. The term might sound like it has something to do with insurance, and that is not completely false either. That is because traders that buy puts do it for the purpose of downside protection and if the underlying asset’s price falls below the strike, the holder of the option stays protected as the writer of the option will buy the asset from them at the fixed price. This way, it serves as a guarantee for the owner.
Protective Put Options can Get Profits on Bitcoin Price Corrections
The strategy consists of selling call options at strikes that are higher than the protective put options a trader simultaneously buys at. This offers profits during bitcoin price corrections as the trades cover the cost of buying but will fetch losses in the case of BTC surpassing a certain threshold.
The trade in the above figure shows buying a single BTC on 26th March put option that has a strike of 56,000 and simultaneous selling of a single BTC contract of the same date call option with a strike of 64,000. The end result between the two strikes is neutral, as shown in the estimate. This means that the trader neither enjoys a profit nor gets hit by a loss as a result of the strategy.
But in the case of BTC dropping by 20% or to 46,000 from 57,500, the trader would profit by 10,200. Similarly, if the price of BTC reaches 69,000 on 26th March, the contract holder would incur a loss of 5,000. To reach 69,000, Bitcoin would have to experience a gain of 20% from the current price. In conclusion, the strategy, even though it is bearish, would inflict traders with losses at 11% above the existing price level or above 64,000.
The strategy is highly favorable for traders that are looking for protection against Bitcoin price corrections as it offers a good risk-reward. Furthermore, other than the collateral deposit and margin requirements, there is no upfront involved in these trades.