What are Crypto Options?
Crypto options are a form of derivative contract (financial contracts that derive their value from an underlying asset, group of assets, or benchmark), that gives traders the right to buy/sell a specific cryptocurrency at a predetermined price and date.
There are two typical sorts of crypto options – call options and put options. In short, a call option allows investors to buy an asset at a specific price on a preset date, while a put option gives the right to sell that asset at a particular price and date.
These financial instruments offer a lot of strategies that can be tailored to various market conditions and individual trading objectives. This article delves into the top 10 strategies for trading crypto options, providing detailed insights into their mechanics, benefits, and potential risks.
10 Crypto Strategies for Crypto Options
Long Call
A long call gives the buyer the right to purchase a cryptocurrency at a specified price (named strike price) before the option’s expiration date. This strategy is primarily used when a trader expects the price of the underlying asset to rise significantly.
When you buy a call option, you pay a premium to the seller for the right to buy the cryptocurrency at the strike price. If the price of the cryptocurrency rises above the strike price, you can exercise the option to buy at the lower price, potentially selling at the current market price for a profit.
Advantages & Disadvantages of long call are:
Benefits
- Unlimited Profit Potential: The potential profit is unlimited as the price can rise indefinitely.
- Limited Risk: The maximum loss is confined to the premium paid for the option.
Risks
- Time Decay: The value of the option diminishes as the expiration date nears, which can erode profits if the underlying asset does not move as expected.
- Volatility Risk: Sudden drops in volatility can negatively impact the value of the call option.
Long Put
A long put allows the holder to sell a cryptocurrency at a predetermined strike price before the option expires. This strategy is used when a trader anticipates a decline in the price of the underlying asset.
Similar to long call, traders pay a premium for their long put. If the price of the cryptocurrency falls below the strike price, you can exercise the option to sell at the higher strike price, thus profiting from the decline.
Advantages & Disadvantages of long put are:
Benefits
- Profit from Declines: Allows traders to benefit from a drop in the price of the underlying asset.
- Limited Risk: The maximum loss is limited to the premium paid for the option.
Risks
- Time Decay: Like a long call, the put option’s value decreases as it approaches expiration.
- Volatility Risk: If the volatility of the cryptocurrency decreases, the value of the put option may decline.
Covered Call
A covered call strategy is when an investor chooses to hold a long position in a cryptocurrency and simultaneously sells a call option on the same asset. This strategy is used to generate additional income from the premiums received from selling the call option.
In fact, you own the underlying cryptocurrency and sell a call option against it. If the price of the cryptocurrency rises above the strike price, you must sell your holdings at the strike price. Consequently, your profit is limited, but you can generate income from the premium.
Advantages & Disadvantages of a covered call are:
Benefits
- Income Generation: Provides additional income through the premiums received.
- Downside Protection: The premium received offers some downside protection.
Risks
- Limited Upside: If the price of the underlying asset rises significantly, the gains are capped at the strike price of the sold call option.
- Full Downside Exposure: The strategy does not protect against significant declines in the price of the underlying asset.
Protective Put
As its name suggests, a protective put strategy means holding a long position in a cryptocurrency and purchasing a put option on that underlying asset. This strategy acts as an insurance policy to protect traders from significant losses.
You buy a put option while holding the underlying asset. If the price of the cryptocurrency falls, the put option increases in value, offsetting the losses from the decline in the underlying asset’s price.
Advantages & Disadvantages of a protective put are:
Benefits
- Downside Protection: Protects against significant declines in the price of the underlying asset.
- Unlimited Upside: Allows the trader to benefit from any price increase in the underlying asset.
Risks
- Cost of Protection: The premium paid for the put option can be expensive, particularly in volatile markets.
Straddle
This strategy allows traders to purchase both a call and a put option with the same strike price and expiration date. When a trader expects a significant price movement but is uncertain about the direction, they can opt for a straddle. Consequently, if the price moves significantly in either direction, one of the options will become profitable.
Benefits
- Profit from Volatility: The strategy profits from significant price movements, regardless of direction.
- Unlimited Profit Potential: Both the call and put options can generate substantial returns if the price moves significantly.
Risks
- High Cost: Purchasing both options can be expensive, and the trader needs a significant price movement to cover the cost of the premiums.
- Time Decay: Both options lose value as the expiration date approaches.
Strangle
This strategy is a derivative of the straddle strategy. A strangle involves purchasing a call and a put option with different strike prices but the same expiration date. This strategy is typically cheaper than a straddle due to the different strike prices.
With strangle, you buy a call option with a higher strike price and a put option with a lower strike price. When the price of the cryptocurrency moves significantly in either direction, one of the options will become profitable.
Advantages & Disadvantages of a strangle are:
Benefits
- Profit from Volatility: Profits from significant price movements, regardless of direction.
- Lower Cost: Cheaper than a straddle due to the different strike prices.
Risks
- Moderate Price Movement Required: Requires a significant price movement to be profitable, but the range of movement needed is broader than a straddle.
- Time Decay: Both options lose value as the expiration date approaches.
Iron Condor
OK, this is going to be a bit more complex. Adopting an iron condor strategy means selling a lower-strike put, buying a higher-strike put, selling a lower-strike call, and buying a higher-strike call, all with the same expiration date. In iron condor, you create a range in which you expect the price to stay. By selling options inside this range and buying options outside this range, you collect premiums from the sold options while limiting your risk with the bought options. This strategy is employed when a trader expects low volatility and a range-bound market.
Benefits
- Income Generation: Generates income through the premiums received from selling the call and put options.
- Limited Risk: The maximum loss is limited to the difference between the strike prices of the bought and sold options, minus the net premium received.
Risks
- Limited Profit Potential: The profit potential is limited to the net premium received.
- Losses if Volatility Increases: The strategy incurs losses if the price of the underlying asset moves significantly outside the range of the strike prices.
Butterfly Spread
When you buy a call (or put) at a lower strike price, sell two calls (or puts) at a middle strike price, and buy a call (or put) at a higher strike price, you are using the butterfly spread. This strategy is employed when a trader expects low volatility and a range-bound market. Essentially, you create a spread with three different strike prices. The middle strike price is where you expect the price to stay, profiting if the price remains near this level at expiration.
Benefits
- Limited Risk: The maximum loss is limited to the initial cost of the spread.
- Potential for High Reward: If the price of the underlying asset remains close to the middle strike price, the strategy can generate substantial returns.
Risks
- Limited Profit Potential: The profit potential is limited to the difference between the strike prices, minus the net premium paid.
- Losses if Volatility Increases: The strategy incurs losses if the price of the underlying asset moves significantly outside the range of the strike prices.
Calendar Spread
When a trader expects low volatility in the short term but anticipates greater volatility in the long term, they can employ the calendar spread strategy. A calendar spread involves buying and selling two options of the same type (either calls or puts) with the same strike price but different expiration dates. You buy a longer-term option and sell a shorter-term option at the same strike price. The strategy profits from the time decay of the shorter-term option.
Benefits
- Income Generation: Generates income through the premiums received from selling the shorter-term option.
- Benefit from Time Decay: Profits from the faster time decay of the shorter-term option.
Risks
- Limited Profit Potential: The profit potential is limited to the difference in premiums between the two options.
- Losses if Volatility Increases: The strategy incurs losses if the price of the underlying asset moves significantly in the short term.
Diagonal Spread
If you are looking for a method that combines elements of both calendar spread and vertical spread, the diagonal spread is the right fit. A diagonal spread requires investors to buy and sell two options of the same type (either calls or puts) with different strike prices and different expiration dates. You create a spread with different strike prices and expiration dates, and by adjusting the strike prices and expiration dates, you can tailor the strategy to your market outlook.
Benefits
- Income Generation: Generates income through the premiums received from selling the shorter-term option.
- Flexibility: Provides flexibility in adjusting the strike prices and expiration dates to suit market conditions.
Risks
- Moderate Price Movement Required: Requires a moderate price movement to be profitable.
- Complexity: More complex to manage than other strategies due to the different strike prices and expiration dates.
