What is an Option?
An option is a derivative financial instrument based on an underlying asset, in our case, BTC or ETH. It is a contract between a buyer and a seller, according to which:
The buyer gets the right but not the obligation to buy/sell the asset at a predetermined price when the expiration date of the contract comes.
The seller is obligated to buy/sell the asset at the request of the buyer, who at the time of the transaction pays the option premium to the seller - a set price specified in the contract.
The predetermined price is called a Strike price of the Option. A strike is a key point when passing this price the contracts purchased become profitable and all settlements are made with reference to this price.
There are options to buy or to sell the underlying asset (ВТС / ЕТН).
A Call Option - grants the option buyer the right to buy the underlying asset at a set price.
A Put Option - grants the option buyer the right to sell the underlying asset at a set price.
So there are four types of possible option transactions:
Buy a Call Option
Write (Sell) a Call Option
Buy a Put Option
Write (Sell) a Put Option
Such instruments open up new opportunities for speculation, however, due to their more complex structure and specificity they are not suitable for every trader. Most likely, those traders who already have a lot of experience in speculative trading will be able to use option strategies most effectively.
On the charts below, the price of the underlying asset is horizontal, and the vertical is a possible profit/loss for a trader using this option strategy.
The easiest and most popular strategy. It is known for its unlimited potential profit when the situation on the market is favorable and limited losses when the underlying asset grows or stands still. It is often used for hedging purposes. Mostly used when the underlying asset price is expected to decline and volatility is expected to increase, for example: you think that by the end of this year the value of Bitcoin (BTC) will be below $20,000, and your friend thinks that it will be higher. Let's say now the Bitcoin price is around $11,000. Your friend can go long on futures (buy contracts for the increase in the price of the underlying asset), according to his strategy, he will profit from any price above $11,000. You don’t have the ability for whatever reason to do the same using futures, but you can take advantage of options! To implement your strategy, by paying a premium you can buy a Put Option with a 12/31/2020 expiration date and a strike price of $20,000.
Buying a Call Option, just like buying a Put Option, is the easiest and most popular strategy. It is known for its unlimited potential profit when the situation on the market is favorable and limited losses when the price of the underlying asset decreases or stands still. It is used when the price of the underlying asset is expected to rise and its volatility is expected to increase. So this strategy is basically the exact opposite of the Long Put strategy.
For example, you think that by the end of this year the value of Bitcoin (BTC) will be higher than $7,000, and your friend thinks that it will be lower. Let's say now the Bitcoin price is around $11,000. Your friend can go short on futures (sell contracts for the increase in the price of the underlying asset), according to his strategy, he will profit from any price below $11,000. For whatever reason, you don’t have the ability to do the same with futures but you can use options! To implement your strategy, by paying a premium you can buy a Call Option with a 12/31/2020 expiration date and a strike price of $11,000.
A Bull Call Spread can be used in a growing market when a moderate increase in the price of the underlying asset is expected
The strategy is similar to Bull Put Spread, but it is based on Put contracts. Just like with bearish spreads, choosing between bullish spreads must be based on the value of each type of contract.
In comparison with Long Call, Bull Call Spread brings bigger profit in the A-B segment than Long Call in the same price range.
Bear Call Spread
Bear Call Spread can be applied in a bearish market when a moderate fall of the price of the underlying asset is expected. This strategy is implemented by selling and buying Call Options with the same expiration date but different strike prices. An option with a lower Strike price is sold (A), and an option with a higher Strike price is bought (B).
The strategy is similar to Bear Put Spread, but it is based on Call contracts. Choosing between Put and Call contracts it is necessary to pay attention to the market sentiment in order to get the maximum profit when some contracts are overvalued, working with others becomes more profitable.
In comparison with Long Put, Bear Call Spread brings bigger profit in the A-B segment than Long Put in the same price range.
Bull Put Spread
The strategy is the opposite of Bear Put Spread, it is also based on Put contracts, but is used when a slight increase is expected.
Bear Put Spread
The strategy is to sell and buy Put Options with the same expiration date, but with different strike prices. An option with a lower strike price is sold (A) and an option with a higher strike price is bought (B). A bearish put spread is used when the underlying asset price is expected to fall moderately.
For example, on this day 08.10.2020, we open Bear Put Spread with the expiration date 08.28.2020 on BTC
To do this, we sell a Put Option with a strike of 8500 at a price of 0.0005 BTC and buy a Put Option with a strike of 11,000 at a price of 0.035 BTC. Therefore, the maximum profitability for the strategy is $11000 - $8500 - 0.0005 BTC - 0.035 BTC = $2080 if BTC falls below $8500. And the possible losses are 0.035 BTC - 0.0005 BTC = 0.0345 BTC ($420) if the BTC price rises above $10,000.
Long Butterfly strategy allows you to get a moderate profit if prices don't change, and limits losses if the underlying asset moves rapidly. It makes most sense to use this strategy during prolonged flat movements.
For better understanding of Long Butterfly strategy let’s split this graph into four areas:
Area 1: We incur a loss that equals the amount of the premiums of Put Option A and Put C minus the premiums received from the sale of two Puts B;
Area 2: The loss of Area 1 is getting “covered” by the growing income of Put A;
Area 3: We start to “pay” on two sold Puts B, “outrunning” the income received from Put A;
Area 4: The same losses as in Area 1.
It is evident that the closer the price of the underlying asset is to the Strike of Put B, the more profit the trader will receive. In other words, while waiting for the Bitcoin price to reach $15,000 next month, you can choose Strike price B - $15,000 and prices A and C respectful to your risk rate. For example like this:
In Short Butterfly strategy, volatility plays a key role. As opposed to Long Butterfly, where traders have to “guess” the Strike price of contracts B (in order to get maximum profit), in Short Butterfly it is necessary to predict the areas where the price will not go.
Short Butterfly can be used when hard forks of an underlying asset occur, when the price rises in anticipation of the drop of the forked coins, as it happened with BTC and BCH. It can be assumed that after the snapshot the price of the underlying asset will fall, but the market can be very unpredictable, therefore, in anticipation of the fork the trader must determine the price of the underlying asset at the time of the snapshot. This value will be the Strike price of Option B. We select Strikes A and C based on desired profits and acceptable risks. The higher the risks, the higher the profit and the further the Strike prices A and C are from the Strike price B.
Long Condor is used when the underlying asset is moving sideways, in a narrow range, when there is no pronounced trend. When the price of the underlying asset is not expected to change, and the volatility is expected to decrease.
Long Condor is used when we aspire to get a bigger profit, more than with the Long Butterfly strategy in cases of slight deviation of the price of the underlying asset from the expected value. Basically, the trader “increases” the area of maximum profit by implementing this strategy.
Short Condor allows you to make a moderate profit if the price of the underlying asset changes and limits losses when the price deviates slightly. This strategy can be used when the trader expects a slight increase or a fall of the underlying asset.
It is used when the change in the price of the underlying asset is expected.
Long Straddle is a strategy for those who love big profits. This strategy is commonly used by investors on the stock market when they expect a significant change in share prices but they're not sure about the direction of this jump. In the crypto world, Long Straddle should be used when forks are expected, just like Short Butterfly.