Bitcoin appears to be struggling at the $ 58,000 level, leading some traders to fear a more significant correction will take place.
While Bitcoin’s (BTC) performance in 2021 has been incredibly strong, its current gain of 696% and comments from US Secretary of the Treasury Janet Yellen suggesting that cryptocurrencies are used to finance terrorism may be enough to make investors feel a bit wary.
Reducing the size of open positions is usually the method that most investors use to reduce exposure, but another way to manage risk is to use BTC option contracts to provide protection. Buying a put option is the easiest way, but it is quite expensive considering the current high volatility scenario.
For example, a March 26 put with a $ 56,000 strike is trading at $ 5,300, and its holder would only benefit if BTC trades below $ 50,700 in 32 days. That would be 12% below the current price of $ 57,500. This cost of protection depends on the number of days until expiration and the implied volatility, or the expectation of the traders of substantial changes in prices.
By using call options and put options, a trader can create strategies to reduce this cost. There are endless possibilities, but for now, let’s focus on a low-cost bassist.
Protective put options can lead to downside returns
This bearish strategy consists of buying a protective call option to benefit from the downturn and at the same time selling call options on higher strikes. These additional trades will cover the cost of the put option, but will result in losses if BTC exceeds a certain threshold.
The above operation consists of buying 1 BTC contract of the March 26 put option with a strike of $ 56,000, while selling 1 BTC contract of the March 26 call option with a strike of $ 64,000.
As the estimate above shows, the bottom line between $ 56,000 and $ 64,000 is neutral. The trader would not incur losses, but neither would he benefit from the strategy. On the other hand, if BTC falls to $ 46,000, or by more than 20% from $ 57,500, the contract holder would benefit by $ 10,200.
For the merchant to incur a loss of $ 5,000, BTC would have to hit $ 69,000 on March 26, which equates to a 20% gain from the current price. Therefore, although this is a bearish strategy, traders would only incur losses above $ 64,000, or 11% above the current price level.
This strategy provides a good risk reward for those seeking protection against losses. Also, there is nothing upfront involved for those trades, except for escrow or margin requirements.
The views and opinions expressed here are solely those of the Authorr and do not necessarily reflect the views of Cointelegraph. Every investment and trade movement involves risk. You should do your own research when making a decision.