Options Trading Strategies: Everything You Need to Know
Anderson Ezieon April 25, 2022.
Options are derivative instruments that give holders the rights without obligations to buy or sell a certain asset such as stocks, cryptocurrency, or commodities for a predetermined price for a limited time. Holders of options pay a premium to ensure that they can buy or sell an asset at a pre-set date irrespective of the asset's price. A call option is the right to buy at a chosen price, while a put option is the right to sell at a determined price at a particular time.
Options are different from futures contracts because holders can decide whether they want to exercise the options or not before the expiry date. If the holder chooses to exercise the option, the option writer must do the same. Options have limited downsides. For example, if you bought a call option, you only have unlimited upsides since there is no limit to how much the stock price can go up. If the stock price or the asset price, such as Bitcoin, falls below the strike price on the expiration date, you only lose the premium paid for the option.
Put options or future sell positions have unlimited downsides, but if the price of the stock or asset increases above the strike price, the maximum debt of the holder is the premium used to purchase the option. The option writer makes profits whenever the stock price goes in the opposite direction, causing the option to expire worthlessly. The profit from the trade is the premium paid on the number of stock purchased in the option. Most option writers profit from issuing a pool of options in which most creators are unsuccessful.
Benefits of Options Trading
Instead of buying the actual asset or cryptocurrencies like Bitcoin or Ethereum, Cryptocurrency traders can hold positions in their preferred underlying asset while saving a lot to use in other trading strategies. If the current price of Bitcoin is $45,000, purchasing 200 Bitcoins at $9,000,000 will be only easy for institutional investors or super-wealthy individuals. Instead of allocating an entire portfolio of $45,000 to the asset, a trader can buy $45 call options of Bitcoin, each representing 100 Bitcoins at (2 contracts x 100 Bitcoins/contract x $45 market price of the option). The resulting amount of $9,000 is used to buy options positions in Bitcoin that allow the trader to profit from 200 Bitcoins. The trader can use the rest of the funds for other investments.
Options offer lower risk for traders and investors. It is the most reliable form of hedging when it is used properly. If you buy a stock and do not want to lose any money on that, you must place a stop order that will expose you to some risk of unprecedented loss, considering that a market order is opened as soon as the stock price hits the set stop. If you bought the strike call of the same asset at less than the price, the worse you can be the premium you paid to buy the call or put option.
Options offer some of the best market opportunities to traders. Although factors like expected volatility, time until expiration and proximity of spot to strike price determine the option premium cost, it is still low. Imagine you bought a call option of 100 Bitcoins valued at $45 per Bitcoin for $4,500. The spot price of Bitcoin is $45,000, and the strike price is $50,000. If you bought the real asset, your profit from the change in price after an increase in the price of Bitcoin to $60,000 would be 33.3%, or $15,000. With your options, you get $1,500, which is the current asset value of 0.10 Bitcoins minus the initial asset value of 0.10 Bitcoins. You now have 100 Bitcoins x $1,500 or $10,500 or 700% in profit.
Variations in Strategies
Options allow traders to trade creatively by creating positions on existing positions. Holding an options position is traditionally hedging, a trading strategy used by the biggest Hedge Funds. Where a crypto exchange does not allow the shorting of assets, options can come in handy. There is also an array of strategies using options.
Types of Options Trading Strategies
Long options allow traders who think the price of an asset will increase in the future to buy smaller units of the asset, exposing them to significant gains if their bet scales through. Suppose a hypothetical trader, Alice thinks that the price of Ethereum will hit $10,000 from its current price of $3,000 in 30-100 days. The trader can buy a long call option which grants the right to buy the underlying asset, in this case, Ethereum, at a strike price of $4,000. Assuming the call option costs $30 for 1 Ethereum, the long call option is in the money when the price goes above $4,000 to $6,000. At this point, the option holder can exercise the option by buying Ethereum for the strike price of $4,000 and reselling it for $6,000, making a profit of $6,000 - $4,000 - $30 = $1,970 if the price does not change or decrease contrary to Alice’s prediction, she only losses the initial $30 which is the premium paid for the option.
A long put option is the opposite of a long call option. In this case, the holder or trader believes that the price of an asset like Ethereum will go down in the future. Continuing with our hypothetical trader Alice, in anticipation of this drop in the price of Ethereum from $6,000 to $1,000, she buys a put option of $30 at a strike price of $4,000. If the price of Ethereum falls to $2,000 after 25 days, Alice will be in a profit of $1,970 from a strike price of $4,000 - $2,000 - $30 if the price does not change or increase, contrary to Alice’s prediction, she only losses the initial $30 which is the premium paid for the option.
An investor who holds a cryptocurrency like Ethereum can write a call option to earn an extra premium from the asset. If the price goes above the strike price, the holder sells to the buyer at the strike price making profits from the increase in price and the option premium. If the asset decreases in price, the premium amount received will mitigate the investor's losses. Suppose there is no change in the asset price when the option expires. The investor or trader can make continuous passive income in premium while retaining the asset.
Protective or Married Put
If you hold some Bitcoins, for example, and you do not want to sell them in the near future, given the volatility of the asset, you can buy a protective put to protect you against the downside. It is similar to buying insurance, and it does not limit the upside of the underlying asset. If the asset price goes above the strike price, you profit from buying at a price higher than the strike price. If the asset price decreases, your loss will be mitigated by profits from the put option. If there is no change in price, you keep the premium as profit upon expiration.
The Most Profitable Options Trading Strategies
The most profitable options trading strategy for cryptocurrency are the long calls, protective put, and the covered call. The long call allows you to reap the complete profits of the underlying assets with less risk. Again, if Bitcoin dips in the short-term and still rallies in price before the expiration date, you can still make a profit. Using protective puts, you can sell your cryptocurrency at the strike price even though the price of the underlying asset crashes. If there is no crash, however, the option expires worthless. Covered calls are great if you think Bitcoin will go down in price, trade sideways, or never move as far as the strike price you are selling. In this case, you can keep earning the premium while the option expires worthless for the buyer.