Bitcoin appears to be struggling at the $ 58,000 level, leading some traders to fear that a more significant correction may occur.
While Bitcoin (BTC) 2021’s performance has been incredibly strong, its current gain of 696% and comments from US Treasury Secretary Janet Yellen suggesting that cryptocurrencies are being used to finance terrorism could enough to make investors feel a little cautious.
Reducing the size of open positions is usually the method most investors use to reduce exposure, but another way to manage risk is to use BTC options contracts to provide protection. Buying a put option is the easiest way, but it is quite expensive given the current high volatility scenario.
For example, a March 26 put option with a strike of $ 56,000 is trading at $ 5,300, and its holder would only profit if BTC trades below $ 50,700 in 32 days. This would be 12% lower than the current price of $ 57,500. This cost of protection depends on the number of days until expiration and implied volatility, or traders’ expectation of substantial price movements.
By using buy (buy) and sell (sell) options, a trader can create strategies to reduce this cost. The possibilities are endless, but for now let’s focus on a low cost drop.
Protective puts can generate a profit on the downside
This bearish strategy involves buying a protective put in order to profit from the downside while simultaneously selling call options at higher strikes. These additional trades will cover the cost of the put option but will result in losses if the BTC exceeds a certain threshold.
The above transaction is to buy 1 BTC contract of the March 26 put option with a strike of $ 56,000, while selling 1 BTC contract of the call option of March 26 with a strike of $ 64,000.
As the estimate above shows, the end result between $ 56,000 and $ 64,000 is neutral. The trader would not suffer any loss, but also would not profit from the strategy. On the other hand, if BTC drops to $ 46,000, or more than 20% from $ 57,500, the contract holder would earn $ 10,200.
For the trader to take a loss of $ 5,000, BTC would need to reach $ 69,000 on March 26, which equates to a 20% gain from the current price. Therefore, even if this is a bearish strategy, traders would only suffer losses greater than $ 64,000, or 11% above the current price level.
This strategy offers good risk-reward for those looking for downside protection. In addition, there is no initial commitment for these transactions, except for margin or collateral deposit requirements.
The views and opinions expressed herein are solely those of author and do not necessarily reflect the views of TBEN. Every investment and trading move involves risk. You need to do your own research when making a decision.