Understanding Crypto Options Strategies

An option is a type of derivatives contract that conveys the right (but not the obligation) to buy or sell an asset on or before the contract expiry date at a pre-agreed price, known as the strike price.

Options types and features

All options contracts feature a standard set of information, which are:

• The name of the underlying asset.
• The strike price.
• The size of the contract, as in the number of units of the underlying asset it represents (100 shares, or one BTC, for example.)
• The expiry date.
• Whether it is an American or European-style option. European options can only be exercised on the expiry date, while American options can be exercised any time in advance of the expiry date.
• Whether the option is a call option, conveying the right to buy, or a put option, conveying the right to sell an asset.

In addition to these features, options contracts are based on the current market rate of the underlying asset and can be classed as either:

• In-the-money : the strike price is lower than the market rate and can be exercised at a profit.
• At-the-money : the strike price matches the market rate.
• Out-of-the-money : the strike price is higher than the market rate, rendering the option effectively worthless.

Exercising at the strike price would mean incurring a loss compared to the market rate, so the option will simply expire.

Since all types can expire without being exercised, options contracts also come with a premium paid by the contract buyer to the contract seller.

Basic strategies for crypto options traders

Basic crypto options strategies offer straightforward ways to hedge against risk and can be used by traders at all levels.

Protective put

A protective put, also known as a married put, is perhaps the most straightforward strategy for trading cryptocurrency options and is used to protect a long position against downside risk.

Example: A trader holds one BTC. To implement a protective put, they buy a put option at the money, allowing them to sell one BTC at the current (strike) price. If BTC prices rise, they will only lose the value of the premium paid for the option and otherwise profit from the gain. If the price goes down, they can sell at the strike price and protect themselves against the downside.

Covered call

A covered call can be deployed when a trader anticipates low price volatility. It caps the upside but offers the chance of a higher yield since the trader can make a profit from the premium of selling an option.

Example: A trader holds one BTC. To implement a covered call, they sell a call option, allowing the buyer the right to buy one BTC at the strike price. If BTC prices rise sufficiently, the trader will be forced to sell at the strike price once the option buyer exercises their option. Thus, their upside is capped to the value of the strike price. However, if the price doesn’t rise sufficiently, the trader has the profit from the sale of the expired option, and since they are still holding the underlying asset, can sell another call option in the next trading period.

Protective collar

A protective collar is typically used when a trader wants to protect the unrealized profit in a bullish position. It offers protection against downside losses, with the caveat that the trader must be willing to sell and take profit at a certain price.

Example: After some bullish action, a trader holds 1 BTC at the price of $50,000. They purchase an out-of-the-money put option at the price of $47,500 and simultaneously sell an out-of-the-money call option for $52,500. If the price falls below $47,500, the trader can exercise their put option and protect themselves against further losses. Conversely, if the price goes up, they are obliged to sell when the call option is exercised but can still take the profit from selling their underlying position.

Intermediate crypto options strategies

Intermediate strategies in crypto can offer more flexibility for traders with some experience and a specific price target in mind.

Long call spread

Traders with a bullish price target can use a kind of vertical spread strategy known as a long call spread. It involves buying and selling options of the same type and expiry date but with a different strike price to maximize the risk and return ratio compared to other types of strategies, such as buying covered calls.

Example: To set up a bull call spread, a trader buys a call for one BTC at a price of $50,000 and sells a call at the price of $52,500. If the price goes up, the trader caps their upside with the $52,500 price they are forced to sell at. However, the sale premium for the call at the higher strike price offsets the premium spent on buying the call at the lower strike price.

Long-put spread

The long-put spread is the inverse vertical spread strategy of the long call spread, where a trader is expecting a bearish price movement. It offers similar benefits from the opposite position.

Example: The trader purchases a put option for one BTC at a price of $50,000 and sells a second put option for the lower strike price of $47,500. The sale revenue offsets the cost of taking out a pure put position but offers limited upside.

Advanced crypto options strategies

Advanced strategies for trading cryptocurrency options are suitable for experienced traders. This category includes straddles, strangles, and advanced spreads.

Long straddle and long strangle

The long straddle and long strangle strategies can be used when the trader believes that there’s a chance the market will make a significant move but isn’t sure on the direction. In the crypto-asset markets, this could happen where a significant announcement regarding regulation or macroeconomic matters is due to take place.

A long straddle involves the simultaneous purchase of a call and put option based on the same asset with the same strike price and expiry date. In contrast, a long strangle involves a similar trade but with different strike prices – out-of-the-money on both call and put, but with the same expiry date.

Both strategies involve a similar wager on the markets, but typically, a straddle incurs higher premium costs since the options contracts are in-the-money. However, providing the market moves from the strike price, premium costs can be offset.

Conversely, the out-of-the-money options in a strangle trade will cost less up front, but prices must move into the money for the strategy to generate profit.

Advanced spreads

There are several different types of more advanced crypto options spread strategies that can be used to anticipate different types of market movements. The long call butterfly spread, iron condor, and iron butterfly all use advanced combinations of spreads based on different positions of calls and puts designed to achieve specific outcomes.

For example, the long call butterfly spread is used when the trader anticipates minimal price movements before the options expire. The trader will purchase one in-the-money call option and an out-of-the-money call option while selling two call options at-the-money. This construction yields the highest returns when the asset price stays as close to or at the at-the-money strike price.

Calendar spreads are another form of spread that involves taking out opposing options contracts on the same underlying asset but with different expiration dates. This type of spread can be used when the trader anticipates changes in the asset's future volatility.

Risks and rewards

In crypto, options markets can still be relatively immature, and some of these strategies may prove to be virtually impossible for assets of lower market cap, since there simply isn’t a large enough market with sufficient open interest to make them viable.

However, if focusing on large-cap assets like BTC or ETH, options strategies are a way for more advanced traders to hedge risk and optimize a portfolio for returns. Using an options strategy typically limits the amount of profit available so it will not necessarily be attractive for traders seeking unlimited upside. Due to the premiums and costs involved in writing contracts, it can also involve more outlay than trading in spot markets or futures. However, options can provide a more stable way to generate returns without taking outsized risks.

Crypto options strategies essentials

• Options strategies in crypto are designed to exploit the specific characteristics of options contracts, which convey the right to buy or sell an asset before a fixed expiry date.
• Basic strategies are aimed at limiting losses if the market moves against long or short positions.
• More advanced crypto options and strategies aim to maximize profit-making opportunities even for minor market movements.