Put Options: Manage Investment Risks
Last updated
Last updated
Crypto put options are specialized financial instruments, giving the buyer the right but not the obligation to sell a predetermined quantity of an underlying asset at a fixed price, known as the strike price, within a defined time frame, referred to as the "expiration time."
These options can be traded on various assets, including stocks, bonds, indexes, futures, or cryptocurrencies. A put option holder doesn’t need to own the underlying asset. Each contract represents a set amount of the underlying asset, like one crypto option contract on BTC symbolizing the control of 1 BTC token.
The buyer pays a premium, a specific fee to the seller, to obtain the contract. The value of a put option generally increases as the price of the underlying asset decreases. Several factors influence the price, such as the crypto market's volatility, interest rates, time decay, and strike price.
Crypto put options derive their value from the potential decrease in the underlying asset's price. As the asset's price drops, the put option's value increases, and vice versa. Traders use put options for hedging against declines or speculating on downward trends.
The concept of the "protective put" is utilized to safeguard against the asset's price falling beneath a certain level. A trader can either buy or sell a put option, transacted on a cryptocurrency exchange, predicting the asset's value movement before the expiration date.
Put and call options are the two main types of options, with different profit mechanisms. A put option profits from a fall in the asset's market price, while a call option profits from a rise.
Consider Sandra buying a Bitcoin put option, believing a bear market is imminent. She wants to protect her position and not lose more than 10% of her investment in Bitcoin. If Bitcoin is trading at $30,000, she might buy a put option allowing her to sell at $27,000 within two years. If a 20% loss occurs within six months, she can still sell at $27,000, limiting her loss to only 10%. If the market doesn't drop, she may let the put expire, losing only the premium.
A long put strategy involves the purchase of a put option with the anticipation that the underlying asset's price will fall below the strike price before the option expires. This strategy offers the potential for significant gains if the asset price falls significantly, while the loss is limited to the premium paid if the asset price rises.
Suppose a trader purchases a put option for Stock Q, which is currently trading at $30 per share. The option has a strike price of $30 and a four-month expiration, with a premium of $1 per share.
If the stock price falls to $29 at expiration, the put option breaks even.
If the stock price falls between $29 and $30, a net loss is recorded, as only part of the option's premium is recovered.
If the stock falls below $29, the trader gains $100 for every share they own. The lower the price, the higher the profit.
If the stock rises above $30, the put becomes valueless, and the trader loses the option premium of $100.
A protective put is a strategy used when you have an underlying long crypto position, and you want to hedge against market uncertainty. It's a low-risk strategy that never loses more than the amount of premium you've paid for the option.
Suppose you are long 0.20 BTC, purchased at $20,000, with the current market price being $30,000. Your long position shows a healthy profit of $2,000 ($10,000 × 0.20 BTC). Although you believe BTC will move higher, you want to protect your profit from near-term weakness.
Buy 0.20 of a BTC $27,000 put, expiring in 60 days, costing $500. Ideally, choose a put with at least 60 days to expiration to benefit from slow time decay in the early stages.
The beauty of the protective put is that it covers you if BTC falls below $26,500 (strike price − premium), but leaves the upside open for you to profit if the market moves higher.
Although buying a put costs money, it's a small price to protect yourself from extreme volatility.
Potential Profits: You make money when the underlying goes up more than the premium paid. This strategy helps to protect your underlying long position if the price falls below strike price A while the Option contract is active.
Potential Losses: In terms of loss, you could potentially lose the amount of premium you’ve paid for the Option.
The protective put strategy showcases how put options can be specifically tailored to safeguard an existing investment against adverse price movements, without sacrificing the potential for further gains if the market moves favorably. It's a valuable tool for crypto investors looking to manage risk in volatile market conditions.
By understanding these strategies, traders can employ put options to better align with their market views and risk preferences, thereby enhancing their ability to profit from the market's movements.
