Options Unveiled
Crypto Options 101
Have you heard about options but found them confusing?
Don’t worry!
This guide is here to help you understand options in a simple and educational way.
Let’s start with the basics.
What Are Options?
Options are financial contracts that give you the right, but not the obligation, to buy or sell an underlying asset (such as Ether) at a specific price (called the strike price) on or before a certain date (known as the expiry date).
Why Trade Options?
Options offer great versatility and can be used to achieve different goals:
Leverage / Speculation
Want to amplify your potential gains? Options allow you to speculate on the price direction of an asset with less capital compared to buying the asset itself. Let’s say Alice is bullish and believes the ETH price is going up within the next month. Alice can either buy spot ETH, enter into a long perpetual position with leverage, or buy a call option.
Buying a call option, instead of a spot asset or a long perp, is attractive because options provide leverage without the risk of liquidation.
Protection / Hedging
Worried about potential losses? Options can act as insurance for your portfolio, protecting you against price declines. Let’s say Bob would like to long ETH but also limit losses if the price moves to the downside. Bob can long ETH but also buy put options as protection, limiting the downside, reducing risk, and enjoying the potential upside movements in a cost-effective manner.
Income Generation
Looking to generate extra income? Options enable you to sell contracts and collect premiums, adding to your overall returns. Alice can sell put options collecting premiums and enabling herself to buy ETH at a lower cost basis in the future. Other the other hand, Bob can trade covered calls, where Bob sells a call option while owning the equivalent amount of the underlying asset (ETH), producing income on a regular basis.
How to Trade Options?
Now that we understand the why, let’s explore some basic options trading strategies:
Long Calls
Feeling bullish? A long call is your go-to strategy. It involves buying call options, giving you the right to buy an asset at a specific price before the expiry date. With limited downside risk and potential for unlimited profits, it’s like having a lever to amplify your gains.
Long call options give the buyer the right, but not the obligation, to buy the underlying asset at the strike price before the expiration. The cost to enter the trade is called the premium.
Payoff
A long call is a savvy choice for traders with a bullish outlook, anticipating an increase in the underlying asset’s price before the option expires. It offers several advantages. Firstly, it requires less capital compared to buying the asset outright, providing leverage. Secondly, if the market takes an unexpected turn and the price drops, the losses are limited to the premium paid, offering a level of protection.
Example
- ETH Price: $1,850
- Sentiment: Bullish
- Strategy: Long Call
- Option: BUY ETH 30JUN23 $2000 CALL
- Trade: Buy
- Type: Call
- Expiry: 30 June 2023
- Strike: $2,000
- Premium: $35
- Breakeven: $2,035 (strike price + premium paid)
At expiry, on 30 June 2023, there are 2 possible payoffs:
- ETH price is above $2,035: the trader is making a profit, the higher the ETH price the higher the profit.
- ETH price is below $2,035: the trader is recording a loss. The max amount of the loss is equal to the premium paid.
This strategy is ideal for traders looking to get leverage to take advantage of upward price movements, with limited downside risk.
Strategy Highlights
- Market Outlook: Bullish 📈
- Profit Potential: Unlimited
- Risk Strategy: Defined
- Setup: Single-leg
- Premium: Pay to enter the position
- Collateral: Not Required
- Volatility: Benefit from volatility increase 📈
- Time: Lose value as time passes
Long Puts
If you anticipate a downward trend, a long put is your friend. Buying put options gives you the right to sell an asset at a predetermined price before the expiry date. This strategy helps you limit your losses while giving you the opportunity to profit from falling prices.
Long put options give the buyer the right, but not the obligation, to sell the underlying asset at the strike price before the expiration. The cost to enter the trade is called the premium.
The long put option strategy is the counterpart of the long call option strategy. When a trader believes that the price of the underlying asset will decrease before the expiration date, they can employ a long put strategy. What makes long put options appealing is that the potential loss is limited to the premium paid, unlike short positions which carry the risk of unlimited losses due to the absence of an upper price limit for the underlying asset.
Example
- ETH Price: $1,850
- Sentiment: Bearish
- Strategy: Long Put
- Option: BUY ETH 30JUN23 $1700 PUT
- Trade: Buy
- Type: Put
- Expiry: 30 June 2023
- Strike: $1,700
- Premium: $25
- Breakeven: $1,675 (strike price — premium paid)
At expiry, on 30 June 2023, there are 2 possible payoffs:
- ETH price is below $1,675: the trade is making a profit, the lower the ETH price the higher the profit.
- ETH price is above $1,675: the trader is recording a loss. The max amount of the loss is equal the premium paid.
This strategy is ideal for traders looking to get leverage to take advantage of falling price movements, with limited risk.
Strategy Highlights
- Market Outlook: Bearish 📉
- Profit Potential: Unlimited
- Risk Strategy: Defined
- Setup: Single-leg
- Premium: Pay to enter the position
- Collateral: Not Required
- Volatility: Benefit with volatility increase 📈
- Time: Lose value as time passes
Short Calls / Naked Calls
Do you expect a stagnant or slightly bearish market? Selling call options, also known as writing naked calls, can generate income for you. However, be cautious; this strategy has unlimited downside risk if the market moves against your position.
A short call is when a call option is sold without owning the underlying asset to receive a premium upfront, the counterpart to the long call. The strategy is considered naked since it lacks protection if the underlying asset’s price rises against the short call position.
A seller of call options, wants the underlying price to decrease, so that they end up profiting.
Payoff
Selling naked calls offers a leveraged alternative to traditional short selling. It allows sellers to earn premium income without actually selling the underlying asset.
Short calls come with a limited upside profit potential, which is determined by the premium received upfront. However, they also pose a potentially unlimited downside risk. The primary objective for a short call trader is to let the option expire worthless, maximizing their profit. It’s important to note that the maximum loss when shorting calls can be unlimited.
Example
- ETH Price: $1,850
- Sentiment: Bearish
- Strategy: Short Call
- Option: SELL ETH 30JUN23 $2000 CALL
- Trade: Sell
- Type: Call
- Expiry: 30 June 2023
- Strike: $2,000
- Premium: $35
- Breakeven: $2,035 (strike price + premium received)
At expiry, on 30 June 2023, there are 2 possible payoffs:
- ETH price is below $2,035: the trader is making $35 profit (premium received upfront)
- ETH price is above $2,035: the trader is recording a loss. The amount of the loss is equal to spot price — breakeven price
This strategy is ideal for traders looking to generate income by collecting the premium upfront and expecting the underlying price to stay flat or fall so the call option expires worthless.
Strategy Highlights
- Market Outlook: Bearish 📉
- Profit Potential: Defined max profit
- Risk Strategy: Undefined max loss
- Setup: Single-leg
- Premium: Receive to enter the position
- Collateral: Required
- Volatility: Benefit with volatility decrease 📉
- Time: Gain value as time passes
Short Puts / Naked Puts
Looking for income and expecting a stable or slightly bullish market? Writing put options, known as naked puts, can help you collect premiums while positioning yourself to buy the underlying asset at a lower price if it decreases.
A short put is when a put option is sold to receive a premium upfront, the counterpart to the long put. The strategy is considered naked since it lacks protection if the underlying asset’s price rises against the short put position.
A seller of put options wants the underlying price to increase so that they end up profiting.
Payoff
Selling naked puts provides a leveraged alternative to buying the underlying assets, allowing sellers to generate premium income without actually owning the assets.
Short puts come with a capped upside profit potential (limited to the premium received upfront) and the possibility of unlimited downside losses. The primary objective for a short put option trader is to let the option expire worthless. However, it’s important to note that the maximum loss for shorting puts can be unlimited.
Example
- ETH Price: $1,850
- Sentiment: Bullish
- Strategy: Short Put
- Option: SELL ETH 30JUN23 $1700 PUT
- Trade: Sell
- Type: Put
- Expiry: 30 June 2023
- Strike: $1,700
- Premium: $25
- Breakeven: $1,675 (strike price — premium received)
At expiry, on 30 June 2023, there are 2 possible payoffs:
- ETH price is above $1,675: the trader is making $25 profit (premium received upfront)
- ETH price is below $1,675: the trader is recording a loss. The amount of the loss is equal to breakeven price — spot price
This strategy is ideal for traders looking to generate income by collecting the premium upfront and expecting the underlying price to stay flat or increase so the put option expires worthless.
Strategy Highlights
- Market Outlook: Bullish 📈
- Profit Potential: Defined max profit
- Risk Strategy: Undefined max loss
- Setup: Single-leg
- Premium: Receive to enter the position
- Collateral: Required
- Volatility: Benefit with volatility decrease 📉
- Time: Gain value as time passes
Covered Calls
Are you holding a long position and want to generate income? Covered calls are a great strategy. By selling call options against your existing holdings, you can earn premiums while still benefiting from potential price increases.
A covered call is an undefined risk, neutral strategy, that combines a long underlying instrument position with selling a call option. Covered calls are profitable when the underlying price increases slightly.
What sets covered calls apart from naked calls is that the seller holds the equivalent amount of the underlying asset while selling the call. This strategic move aims to generate a steady income stream from the portfolio.
Payoff
Covered calls provide sellers with an opportunity to earn extra income through the option premium while holding the underlying asset. They work best when minor movements (upward or downward) are anticipated in the underlying asset’s price.
Additionally, a covered call can serve as a short-term hedge for a long position. However, it’s important to note that sellers may forego potential gains if the underlying price surpasses the strike price.
While covered calls have a limited profit potential and do not eliminate downside risk entirely, they effectively mitigate the risk of the underlying instrument by the amount of the premium received. This can add an extra layer of protection for sellers.
Example
- ETH Price: $1,850
- Sentiment: Neutral
- Strategy: Covered Call
- Option: SELL ETH 30JUN23 $2000 CALL
- Trade: Sell
- Type: Call
- Expiry: 30 June 2023
- Strike: $2,000
- Premium: $25
- Underlying Instrument: BUY Spot ETH at $1,850
- Breakeven: $1,825: Since ETH is bought at $1850 and strike price for the call option is $2000 the original position cost is reduced by $25 (premium received), making the cost basis and so the break even of the underlying position at $1825.
At expiry, on 30 June 2023, there are 3 possible payoffs:
- ETH price is below $1,825: The call option will expire worthless and the trader can keep the premium but will also record a loss on the underlying. Therefore, by using the covered call, they outperformed holding the underlying instrument
- ETH price is between $1,825 and $2,000: The call will expire worthless and the trader can keep the premium recording an overall profit equal to the spot price minus the breakeven
- ETH price is above $2,000: The call will be exercised and the increase in ETH price is compensated by the loss of the call option. Therefore, the trader would have been better off holding ETH. The profit is capped at the strike price minus the breakeven. Although, if the trader planned to sell ETH at $2000 anyway, entering the call option gave an extra $25.
This strategy is ideal if an investor is looking to hold the underlying instrument for a long time but does not expect a price increase in the short term. By using a covered call, an investor can generate income (in the form of a premium) while waiting for a bull run.
Strategy Highlights
- Market Outlook: Neutral
- Profit Potential: Defined max profit
- Risk Strategy: Undefined max loss
- Setup: Combine selling call + holding the underlying asset
- Premium: Receive to enter the position
- Collateral: Required
- Volatility: Benefit with volatility decrease 📉
- Time: Gain value as time passes
What’s Next?
Remember, options trading can be both rewarding and risky. Understanding the intricacies of each strategy is key to making informed decisions and managing your positions effectively. But with a bit of knowledge and a sprinkle of humor, you’ll be navigating the options market like a pro in no time!
Trade options with Rysk from 26th July 2023! 👉 https://app.rysk.finance
Happy trading, and may the options be ever in your favor!
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