Options trading strategy is extensively exercised in crypto markets. It allows traders to hedge risk in volatile markets. Options are a source of insurance for traders and investors. In all traditional financial markets, the buyers and sellers take advantage of options trading strategies. However, it is becoming the fastest-growing derivative in the cryptocurrency space.
What Is an Options Trading Strategy?
An options contract is an agreement that gives the right to buy/sell an underlying asset (cryptocurrency, forex currency, or stock) at an agreed-upon price on or before a set date. The contract is an exchange between two parties for some premium price. This contract sounds similar to ‘futures’. However, unlike futures, there is no binding on the buyer or seller to execute the order when the time comes.
Options traders bet on the price of an asset. They make buy/sell decisions beforehand, keeping in view the market situation.
Option Trader Types
There are two basic types of Option Orders.
Call Options: It is a derivative that confers the right to buy an asset, cryptocurrency in this case, upon the owner. A trader typically enters the call option when he expects the price of a coin to rise. Calls would give him the leverage to purchase the asset at a value lower than the market price.
Put Options: Put options give the right to sell an asset for an agreed-upon price on or before the particular date. The owner of puts usually anticipates a fall in the asset price. Therefore, the contract allows him to sell an asset at a price higher than the market value.
Puts and calls are bets in favour or against the market volatility. Besides, sometimes traders enter either of two options expecting the market price to stay stable.
Components of Options Trading:
There are four basic components of options order.
Size: The number of contracts traded between the buyer and seller.
Strike Price: The agreed-upon price between the parties to the contract.
Expiration Date: The expiration date is the ‘particular date’ after which a trader cannot execute the option order. The American options contract allow the buyers to exercise their choice at any time before the expiration date. Whereas, the European options contract can only be exercised on the expiration date.
Premium: It is the price that traders pay for owning the contract. Premium price constantly changes with expiration date closing in.
The buyer of the options contract gets the choice of buying (or not buying) an asset on strike price before the expiration date. This choice is earned by paying the premium. As mentioned earlier, the contract is not legally binding. Therefore, the trader may or may not exercise his choice in the days leading up to the expiration.
Example of Options Contract:
Peter and Jane have a contract in which Peter agrees to buy 3 BNBs (Binance Coin) for $200 each before the 1st of May. The total price of 3 BNB is $600 according to the calculation. He pays $300 to Jane as a premium for this calls options.
Now, the price of 1 BNB hits $400 before the expiration date making 3 coins worth $1,200. Peter decides to exercise his choice. He buys 3 BNBs for $600. Adding the premium into the equation, the purchase costs him $900. It is still $300 less than the market price of 3 BNB at the moment. Hence our guy Peter just made a profit.
Consider another scenario. BNB price falls to $100. Now, the price of 3 coins is $300. Peter decides to not execute his order because buying each BNB at $200, as per contract, will cost him a $300 loss in total. He protects himself against the price drop. However, the premium is gone.
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Sellers or writers of the contract have their fate dependent on buyers’ decision. In case of a call option, the writer is obligated to sell the asset if the buyer decides to purchase them. Likewise, the put option makes it binding on the writer to acquire the underlying asset if the other party decides to sell it before or on the expiration date. Sellers do get to keep the premium. However, loses can be huge if the market price goes significantly higher/lower than the strike price.
How to Trade Crypto Options:
The crypto market is getting a lot of attention lately. Retail investors are increasingly trading crypto to profit from market volatility. The crypto derivatives can prove to be a hedge against the risk. Moreover, traders can increase their earnings by leveraging positions. Multiple components of the options contract are especially useful in the crypto market.
There are numerous strategies to profit from trading crypto options. Here are some of them.
Options Trading Strategies in Crypto Market:
Crypto traders can leverage four different positions in the options market. A buyer can either buy a call option (right to buy) or put option (right to sell). A seller can sell call or put options for the premium price. Seller or writers have to complete their part of the deal if the contract holder decides to exercise options.
Here are 4 options trading strategies containing combinations of call and put contracts.
The trader buys put options contract of an asset which he/she already owns. It allows them to hedge the risk in case the price starts declining. For instance, Jane buys 10 BNBs for $100 each. She is fearful of the price decline. So she buys put options with a $95 strike price and pays $5 in premium. If her fears come true and the market price of BNB falls to $50 per coin, then she can exercise her contract and sell the currency at a $95 rate. However, if the coin becomes bullish then Jane will only lose the premium.
This strategy protects the portfolio of investors.
The covered call is an options trading strategy in which investors buy a cryptocurrency and then sell its call options. The trader makes additional income by collecting options premium. If the buyer of the contract exercises it before expiration, then traders are bound to sell their holdings. In the case of market decline, they keep the asset as well as the premium.
Long Straddle Strategy:
In the volatile market of cryptocurrency, traders often go for a straddle strategy. It involves betting on volatility. The trader buys call options and put options of the same coin with identical expiration dates and strike prices. It allows him to take profit when the market price of the asset either significantly increases or decreases.
Long Strangle Strategy:
The trader buys both call and put options of the same asset. The strike price for a call option is above the market price. Whereas, the put option strike price is below the market price. Strangle strategy resembles straddle in its make up. However, the former is profitable only when the market is highly volatile.
Benefits of Options Trading Strategies
The goal of all cryptocurrency trading strategies is to make profits in the long run. In this regards, the following benefits are attached to the options trading strategies.
- It allows traders to hedge the risk posed by the volatile crypto market.
- Options present flexibility during the time of market speculations. You can use both put and call options contracts and benefit from price movements.
- The option trading strategies allow you to profit from all kinds of market trends.
- Traders can execute multiple orders simultaneously by exercising their contracts through an options trading strategy.
- At the time of buying the contract, the trader only has to pay the premium. This reduces the cost of entering the position.
Cons of Options Trading Strategies
Options traders are not always successful in the end. There are some disadvantages of trading options in the crypto market as well.
- Crypto options can be confusing for a layman or beginner trader.
- The seller or writers of options contract have the short end of the stick. They can lose big if the market moves in unfortunate directions.
- Options are more complex than futures and other alternative trading strategies.
- The number of options traders in the market is less than spot traders. Thus, options trading platforms tend to have low liquidity which makes them unattractive for most crypto traders.
- The premium value is also a bane to bear in the crypto options market. It gets lower with the expiration date closing in.
Best Options Trading Platforms for Crypto Traders:
The famous cryptocurrency exchanges allow traders to do options trading. However, the following trading platforms are best for trading crypto options.
Deribit is a derivatives exchange based in the Netherlands. It facilitates a large range of options contracts. Moreover, the fee on exchange for trading crypto options is low.
FTX platform has high trading activity. It is another derivative exchange. Users of FTX get to trade a wide variety of products like crypto options, leveraged tokens, and futures.
FTX has a high liquid market with a trading fee of 0.05%. The best part is that you can get quotes for the strike prices and expiration dates of your choice.
LedgerX is a crypto options trading exchange based in the USA. It allows bitcoin options along with bitcoin binary options. It is regulated and thus has institutional level security.
Traders can choose options trading platforms of their choice based on their portfolio and trading experience. Nonetheless, crypto options are a great way to protect yourself against the risk posed by the unpredictable crypto market.
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Options trading strategies allow investors and traders to buy/sell an asset at a fixed price in the future. As the contract is not binding, so they can opt-out of it when the time comes. Hence trader has leverage in the long run. Options trading strategy is especially helpful in the volatile crypto market.
However, the risks are imminent and sometimes quadrupled with options. So, it is necessary to have a good understanding of options derivative before you buy a contract.