What Are Crypto Options?

Options are contracts to either buy or sell an asset such as a cryptocurrency, stock, or futures contract as of a future date at a price specified in the contract. Options come in two flavors, calls and puts. With a call contract the buyer agrees to purchase an asset and the seller agrees to sell it at the contract price also called the strike price. The buyer is paying for the right to buy even if the price of the asset, a cryptocurrency, has gone up significantly. The seller is betting that the price of the cryptocurrency or other asset will not go up. Thus he or she will pocket the premium paid for the contract and the buyer will be out the premium he or she paid. The premium or cost of the contract will vary according to how likely the market believes that the price of the asset will rise sufficiently to earn the buyer a profit. Put contracts allow the buyer of the contract to sell an asset at a future date at a set strike price while the seller is obliger to buy.

Where Can You Trade Crypto Options?

The Chicago Board Options Exchange is where one trades stock options and they also support options trading for Bitcoin and Ether. You can also trade options on the Binance, Bybit, OKX, and other crypto exchanges. In all cases you are well advised to learn about options trading and the various strategies that can be employed to gain profits and avoid losses.

What Crypto Options Strategy Is Profitable In a Down Market?

The simple answer to this question is that you want to buy calls on a cryptocurrency when believe it will go up in price and puts when you expect it to go down. However, professional options traders do not just buy calls or puts as a rule. They mix and match calls and puts in order to limit their risk while seeking profits. These are called spreads.

Bear Put Spread

A bear put spread is when you buy a put contract to sell a cryptocurrency at a higher strike price and sell a put contract at a lower strike price. Both put contracts are for the same cryptocurrency with the same contract expiration date. The premium for the put that you sell will be somewhat lower than the premium for the put that you buy. The this spread start with a small expense which is erased as the market price of the cryptocurrency falls. The maximum profit occurs when the market price falls to or below the lower strike price and the maximum loss occurs if the crypto price climbs above the higher strike price. With this approach the trader is trading off a potentially larger profit for a more secure albeit smaller profit and a limit on any potential loss.

Bear Call Spread

 Similar approach is a bear call spread in which the trader buys and sells puts on the same crypto currency with the same expiration date. In this case the purchased call has a lower strike price than the one that the trader sells. Unlike with the bear put spread the bear call spread starts with a slight credit and has a limited loss if the crypto price rises above the upper strike price.

There are many types of spreads and other approaches to trading crypto options in both down and up markets. The smart trader will learn how to use a few of these and apply them wisely. The best way to start is to only trade in simulation trading using one’s work station software. Do not risk your own money on crypto options trading until you fully understand the strategies you will employ and can routinely make a “paper profit” in your simulation trading.

Options Trading Benefits

The first thing one generally thinks of with options is that they help you hedge your risk. However, they also offer an opportunity to leverage your investment and trading capital. Here is how.

Options Trading Benefits

Let us say that you think stock XYZ is about to go up in price. You buy the stock. It may go up, stay the same, or fall in price. If it goes up you have a more valuable stock which you could hold on to or sell. You will have paid fees and commissions to buy the stock. If it does not budge in price you are still out the fees and commissions and still have the stock. If the price goes down subsequent to you purchase you are out fees and commissions and have lost money on the stock should you decide to sell it at the current price. What happens if you use options? If you buy a call option on the stock you will only end up buying it if the price goes up to the price of the options contract. This will cost you the premium as well as fees and commissions. However, you will purchase the sfock at a price less than the now current market value. If you choose to simply sell your now more valuable options contract you will earn something very similar to having bought and sold the stock but will have only invested the premium and not the price of the stock itself. This is your leverage!

Options to Limit Trading Risk

If in the previous example your stock went down in price instead of up, you will have save a significant amount of money because you would not have purchased the stock but simply would have paid a premium for the option to do so, which you obviously did not do. Over time one makes money buying call options if they choose stocks wisely in regard to the stock’s potential for appreciation and in regard to the price of the premium

Bull Call Spread Payout Diagram

How Professionals Trade Options

One is not limited to trading one type of option at a set price for a given stock. Professionals buy and sell options on a stock at the same time. They may choose different contract prices as well. Many times they are not looking to hit a home run with a given trade but to improve their odds of reliably making money each and every time that they compose a set of options trades. As a rule selling options is more profitable than buying them. A typical approach is the Bull Call Spread as noted above. In this case, a professional will typically balance a complex trade by adding a purchase to protect against even the remote possibility of huge loss in case a stock unexpectedly plummets in value. Nobody with any sense just sells options routinely without a offsetting purchase to protect themselves against catastrophic loss.

What Are Options?

Options are contracts in which the buyer of the option pays for the right to buy or sell an asset like a stock on or before a future date at a specified price. The buyer pays a premium for this right. The seller takes on the obligation of fulfilling the contract if and when the buyer desires. In return for taking on this risk the selling is paid a premium. A contract to buy an asset is a call contract and a contract to sell an asset is a put contract. The most basic reason for buying an option is to limit one’s risk. The point of selling an option is to earn a guaranteed return specified by the contract. The buyer will only enter into a call contract if he or she believes an asset like a stock will go up in price. The seller will only sell a call if they believe that the price of the asset will not rise to the contract price. A person buying a call has the potential for large profits with a fixed limit to their losses. Options sellers generally make more money than buyers because they only enter into contracts where the odds are in their favor. However, an options seller always has a potential for a huge loss should the asset price move rapidly and significantly contrary to their expectations. If you are interested in trading options it is wise to start with the easiest contract to understand and the ones with the least risk.

The Long Call Option

If you are long on a call option it simply means that you bought the call contract. This is an option contract where you expect a stock or other asset to go up in price within a given period of time. What you pay for the contract will depend on the likelihood of the price going up to the level of the contract price. This is a simple approach. You will typically not make much on most such call contracts but your risk will also be quite small. The risk, of course, is that the stock price does not go up to the level you expected and you simply lose the premium that you paid. If the stock price goes down instead of up you are still out the premium but that is a much better deal than if you had bought the stock and had to absorb the loss.

Long Call Option Payout

The Covered Call

This is a situation in which the owner of a stock offers to sell it. They will earn a premium paid by the buyer no matter if they purchase the stock or not. The risk is that the stock will go up in price and the owner will have to sell it at the now lower contract price instead of the market price. Because the owner is familiar with the stock they will typically only enter into a contract for a price that is unlikely to be reached within the time frame of the contract. Doing this repeatedly and not having to sell the stock is akin to collecting dividends on the stock.

The Married Put

In this case the owner of a stock has seen his or her investment go up significantly in price but the market has weakened and there is the risk of the stock falling to a much lower price. Here the owner buys a put, the right to sell, on his own stock. If the bottom drops out of the market he or she will still receive the contract price of the put option thus avoiding significant losses. This approach requires the owner to pay a premium for the ”insurance” they are purchasing.

Investing in Dividend Stocks

Companies that have been paying dividends for decades and even more than a century are typically secure investments. When the economy sours, the stock market falls, and investors look for safety they typically buy companies that sell consumer staples, are in the health sector, or have amazingly strong balance sheets. These companies commonly pay dividends as well. If you have put part of your portfolio into a strong dividend stock before a market correction or crash you will typically see a bit of appreciation as other investors pile in later.

Investing with Treasuries and Corporate Bonds

US Treasuries are generally considered to be the most secure interest-bearing investment vehicles followed by AAA corporate bonds. A problem with this approach is that with increasing inflation and interest rates as low as they are today, you are saving with negative real interest rates. Your choices are to use long term treasuries or bonds to get higher interest rates or go very short term and accept extremely low rates. With this approach you will protect your dollars but not necessarily your purchasing power over time. The good part is that if the market does crash, you will have cash to pick up bargains as the market bottoms out.

Portfolio Diversification as a Defensive Investing Strategy

Many investors put their money into several US market sectors as well as abroad in order to benefit from where the growth is. Many also diversify in this manner so that investing mistakes in one sector are hopefully offset by growth in another. The best way to do this for most investors is to put your money into one or more ETFs that track the S&P 500, one or more of its sectors, and foreign markets. A problem for the average investor is that they have a “day job” that takes up the majority of their work day. This makes it difficult to adequately follow more than five or so investments. The ETF approach makes this less of a chore.

Defensive Options Trading Strategies

An approach used by professional investors, as well as options traders, to protect stock positions is to buy puts. A put is an option contract that gives the buyer the right to sell a stock at its contract price (strike price) at any time during the duration of the contract. The buyer is essentially purchasing insurance against the stock (or ETF) being taken down in a correction or crash. If the bottom does fall out of the stock price, the put buyer can execute the contract and sell the stock at the strike price even though it may have fallen ten or twenty percent. Alternatively, they can sell the contract to exit and get cash.

Three Versions of Defensive Puts

The basic defensive put strategy is to buy one more put contracts on the stock that you want to protect. Each contract is for 100 shares.  Depending on how much of a loss you are willing to accept before having the put kick in, you can pay quite a bit for the contract or not very much. Assuming that you hold a lot of the stock and that you set your strike price rather high, this can get to be expensive if you continually roll over the contracts to continue the protection. There are two approaches that make this less expensive.

Synthetic Short Stock

If you are certain that your stock is going to fall in price, you can use a synthetic short stock approach. In this case, you buy a put but also sell a call. While the put you sold gives you the right to purchase the stock, the call contract gives the buyer the right to buy the stock from you at the strike price of the contract. You set this up with the same strike price for the puts and calls and the same expiration date. The premium that you receive for selling the call contract will reduce your cost for the trade and may even leave you with a small credit. If the price goes down you can treat this strategy like a protective put and if it goes up the buyer will execute the contract and you will sell the stock for the strike price. Although this approach is cheaper than a simple put, there are a couple of issues.

Protective Collar

This approach is the same as the synthetic short stock route but it has two advantages. First, it is cheaper and second, it protects you from selling your stock due to normal market fluctuation. A protect collar sets the put and call strike prices at different levels. The put is much lower than the current stock price and the call is much higher. Since the put and call are out-of-the-money, they are cheap. Thus you can use this approach over the long term if you choose to. And, because you set the strike prices far enough apart, you will not end up selling the stock just because the market fluctuates a little and then see the market stabilize.

Defensive Investing Strategies – Slideshare Version

Defensive Investing Strategies – DOC

Defensive Investing Strategies – PDF

VIX as a Measure of Volatility

What is the VIX and is it important to your investing? Investopedia explains VIX.

Created by the Chicago Board Options Exchange (CBOE), the Volatility Index, or VIX, is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors’ sentiments. It is also known by other names like “Fear Gauge” or “Fear Index.” Investors, research analysts and portfolio managers look to VIX values as a way to measure market risk, fear and stress before they take investment decisions.

When the market is going up or staying the same, the VIX is low. When the market is falling the VIX goes up. As an example, at the end of 2008 the VIX went from a normal of 18 up to 81 over a couple of months as the market crashed. The calculation for the VIX is complicated but what it is looking at is puts versus calls as a guide to investor concern.

The VIX is not the only indicator of market volatility offered by the Chicago Board Options Exchange. Others are these.

Cboe ShortTerm Volatility Index (VXSTSM): S&P 500 expected volatility next 9 days
Cboe S&P 500 3-Month Volatility Index (VXVSM)
Cboe S&P 500 6-Month Volatility Index (VXMTSM)

The usefulness of VIX and its relations comes from its “canary in the coal mine” property of predicting a falling market based on the actions of option traders. But, let’s get back to our question. When investments are volatile should you sell or buy? And, is the VIX useful in this regard?

The Importance of Recognizing Market Volatility

The Motley Food writes about why you should care about the VIX.

Some have dubbed the VIX the “Fear Index” because of its tendency to rise when the market drops and to decline when the market rises. Even though traders tend to interpret high VIX levels as danger points, long-term investors can use a high VIX reading as a signal to look more closely at stocks. Once the VIX has risen, some stocks might have had their share prices beaten down already, and others might have higher chances of falling to attractive levels than usual. Using the VIX as an early warning system to start looking for bargain opportunities has been a smart strategy over time, especially in recent years when long periods of low volatility were the norm rather than the exception.

We often suggest the use of intrinsic stock value as an investment guide. When a stock has been beaten down by a fearful market its intrinsic value is often the same as it was before the market panicked. Successful long term investors very often buy into a decline in stock prices in order to pick up bargains for the long term. They are not necessarily expecting the entire market to recover all that soon but the specific investments they buy are those with long term value based on fundamental analysis.

So, a high VIX indicating volatility is not a direct indication to buy but it is an indication that you should look more closely at high intrinsic value stocks that have taken a beating. A reassessment of intrinsic value may be in order. And a laddered approach of buying in increments is a good idea because nobody can precisely time the market. That having been said, when the market has fallen and then VIX falls as well, this is an indicator or stable or rising stock prices.

Why Is the Stock Price Doing What It Is Doing?

We are looking at a technical indicator, the VIX, and suggesting that you use it to carry out fundamental analysis. Why do you need to use both tools? Although markets tend to panic, they often do so for good reasons. The fundamentals, like a trade war, can cause real damage to otherwise healthy companies. We wrote about how the trade war damages investments in agriculture. When an elevated VIX tips you off to look for high intrinsic value stocks, make sure that the fundamentals that are helping drive down the overall market are not ones that will do lasting damage to your chosen investment. In the case of the trade war with China US soybean growers are concerned about the long term loss of a major buyer. Thus, when the VIX goes up and you go hunting for bargains, make sure that your assessments and calculations of intrinsic value are based on current information.

Can You Trade the VIX

Investopedia mentions in their VIX article that VIX-linked securities can be used to hedge risk and balance a portfolio.

Active traders, large institutional investors and hedge fund managers use the VIX-linked securities for portfolio diversification, as historical data demonstrates a strong negative correlation of volatility to the stock market returns ,that is, when stock returns go down, volatility rises and vice versa.

This may be a more sophisticated approach than many mom and pop investors choose to follow but it does indicate the use of this tool beyond its “canary in the coal mine” value. But, if an investor wishes to try this approach it can be a stabilizing factor in their portfolio.

When Investments Are Volatile Should You Sell or Buy? PPT

One of those measures, in particular, has popped up on investor radars lately, and that’s the “Buffett indicator.” The Berkshire BRK.A, +2.83% boss called it “the best single measure of where valuations stand at any given moment.” If historical patterns hold true, a thrashing could be in store for complacent investors.

Put simply, the indicator is the total market cap of all U.S. stocks relative to the country’s GDP. When it’s in the 70% to 80% range, it’s time to throw cash at the market. When it moves well above 100%, it’s time to lean toward risk-off.

Where’s it now? Approaching 140% and a new record high.

A successful long term investor like Buffett relies on the strength of the US economy to drive up the value of his investments. Using intrinsic value as a guide, value investors buy stocks that they understand and stocks that are underpriced in relation to expected long term earnings. Those long term earnings are usually tied to the strength of the US economy. When the value of all US stocks grossly exceeds the value of the US economy, a painful correction is in store.

How Painful Might a Correction Be?

The last two times the total market cap of all stocks grew above the US gross domestic product, the end results were the 2008 stock market crash and the dot com crash. In each case, the losses were huge. The dot com crash erased about $6 Trillion in value. The 2008 financial crash erased closer to $14 Trillion. In the 2008 crash the S&P 500 was cut in half before it started to rise again.

Benefiting from a Market Correction

All of that having been said, not everyone lost money in the dot com and 2008 market crashes. Those who had the foresight to buy puts on their big winners walked away with their profits (minus the cost of the option contracts). Those who simply purchased puts on the most vulnerable stocks made out like bandits and are probably sipping rum drinks and lounging by their pools on their own tropical islands.

Timing a Market Correction

Because perfect market timing is impossible, it can be really difficult to decide when to get out and when to stay in. This is where options are useful because, for a small insurance fee (the premium) one can protect an investment portfolio or nail down a selling price throughout the duration of the options contract. All of this you can do for simply the premium paid for the contract. The leverage that options trading offers can result in spectacular profits when other unwary investors are losing their shirts.

Is This Going to Be a Painful Correction for Unwary Investors? PPT

How to Profit When Other Investors Lose Their Shirts

• Take timely profits
• Be a contrarian
• Options trading

How to Profit When Other Investors Lose Their Shirts: Take timely profits

An old but still-useful investment strategy is to take a profit when you make a profit. As the Facebook experience shows, just because the stock price when up, you did not make money. You only make money when you sell. Because, any investment can always fall in value. The problem with this approach is that you miss out on more profits if the investment continues its upward climb.

How to Profit When Other Investors Lose Their Shirts: Be a contrarian

Warren Buffett famously said that investors should be fearful when everyone else is greedy and greedy when everyone else is fearful. If you combine this contrarian approach with sound analysis of intrinsic stock value, you greatly improve your odds of making a profit when other investors lose their shirts.

How to Profit When Other Investors Lose Their Shirts: Stock options

We have written about how to use options to protect your investment portfolio and how to make money selling options. Another approach is to use options to make money whether a stock goes up or down. Wisely placed options trades take advantage of the leverage that options offer and limit any potential losses to the price of an option contract. We are currently featuring such an approach by the Weekly Money Multiplier in an upcoming webinar. Attend the webinar and learn how to profit when other investors lose their shirts.

The Horse Is Not Out of the Barn

CNBC writes that the horse is out of the barn with Facebook and other tech darlings.

Fears of a widespread tech wreck have been greatly exaggerated, says BTIG’s chief equity and derivatives strategist Julian Emanuel.
Even as Facebook, Twitter, Netflix and Intel were taken to the cleaners after recent earnings reports, Emanuel says one area of the market suggests the selling has reached its peak.

Perhaps Facebook is done falling and maybe it will come back. Or, maybe it will keep falling. For options traders, how to profit when other investors lose their shirts is to be alert for opportunities and learn to limit losses and magnify profits with well-placed trades. If you want to learn how, sign up and attend the webinar.

How to Profit When Other Investors Lose Their Shirts PPT

The Use of Options in Investing

Stock options can be useful in getting into an investment, providing a little extra income along the way, and protecting your investment. The tools of options trading are call and put contracts.

Buying Call Options

Call options can provide a cheap entry into a stock position. How do call options work? Our sister site, Options-Trading-Education.com discusses calls and puts.

A call contract gives the buyer the option to purchase the underlying equity which he will do if the equity price moves in the direction anticipated. A call contract confers an obligation on the seller (writer) of the call option to sell the underlying equity if the buyer executes the contract.

If you the investor expect that a given stock is going to go up in price you may choose to buy a call option on that stock. This option gives you the right to purchase the stock as the contract price, called the strike price, no matter how high the stock price goes. The beauty of the call option is that if the stock price does not go up or even goes down your losses are limited to the price of the options contract. This fact makes call options a valuable tool in a volatile market.

Selling Call Options

If you own a very stable stock it is possible to make extra money by selling call options on that stock. The buyer will believe that the stock price will go up and will pay you a premium to have the right to purchase from you when that happens. If you believe the stock will remain stable and not go up then you can sell call options and make extra money. In the end the option contract will expire, you will still own the stock, and you will make a profit. For more info on this idea, look at the Options-Trading-Education.com article, how to write a covered call.

Buying Put Options

This gets back to our original question. How can you use options to protect your investment portfolio? Do you think that the bull market has run its course and is in danger of a big correction? Do you also believe that not all stocks will fall and that timing a correction is difficult to do? Then you may wish to protect your gains in one or more stocks by buying puts. A put option gives the buyer the right to sell a stock at the contract or strike price no matter how far the price falls. If the stock does not correct you will have paid a premium for the contract and may consider that to be insurance against potential loss.

Risks are stacking up for markets attempting to recover from the latest provocation by North Korea and the mounting damage of Tropical Storm Harvey.

Citigroup Inc. strategists including Jeremy Hale cite “worrying developments” that may signal the approach of a correction in stocks, while Commerzbank AG finds growing evidence of bearish sentiment in bond funds.

They cite the increased number of puts versus calls in the options market, technical factors that typically precede market corrections and an increased appetite for bonds, especially government debt.

Equity investors are willing to pay more for protection against losses than gains. So-called equity implied volatility skews are above the 10-year average, according to the Commerzbank strategists. This implies they are willing to pay more for downside protection than upside potential compared to the last decade.

Investors have stayed in an overpriced market because they believed that economic conditions would improve and because earnings kept improving for stocks like the FANG tech darlings. But there comes a time when enough is enough. And those who are willing to forego that last iota of opportunity in exchange for portfolio protection typically preserve their gains and can reenter the market looking for bargains after a correction plays out. How much should you pay in terms of lost opportunity to protect your portfolio?

Sectors at Risk

Who would have thought that Hurricane Harvey would rise to a category 4 as it hit shore and that it would park itself over the Texas coast dropping several feet of rain on some areas? In an overpriced market it only takes an isolated but significant event to hurt stocks. The Los Angeles Times notes that insurers and energy stocks have been hit by the storm.

Insurance companies and oil drillers stumbled while refineries rose along with gasoline prices.

Investors mostly focused on Harvey, initially a hurricane before becoming a tropical storm, which continues to hit parts of the Gulf Coast with historically heavy rains. Large parts of the energy and petrochemical industries are based there, and companies with a lot of stores in the area stand to lose business. Although gas-price spikes will be temporary, other effects of the storm will last years.

“There will be ripple effects that everyone is going to feel,” said Jack Ablin, chief investment officer for BMO Capital Markets. He said that could include higher insurance premiums, as the storm is likely to cause tens of billions of dollars in flood damage. Ablin added that the storm might also affect interest rates, as the Federal Reserve might hesitate to raise rates if officials think the storm will slow the economy significantly.

Investing in a rising market becomes self-sustaining. Stocks go up because they went up and new buyers expect more of the same. So long as earnings are reasonable this can go on until the market is overpriced by measures of intrinsic stock value. Considering an already overpriced market there are two options to protect your portfolio. One is to buy put options at increasing prices as everyone is doing that now. The other is to buy secure bonds before the prices go up due to increased buying by those fleeing a collapsing stock market.

How Much Should You Pay to Protect Your Portfolio? DOC

How Much Should You Pay to Protect Your Portfolio? PDF

How Much Should You Pay to Protect Your Portfolio? PPT

The S&P 500’s price-to-earnings ratio, which compares the price of the S&P to analyst projections of what S&P companies will earn over the next 12 months, has risen to 16.6, according to FactSet. Not only is that above historical norms, but it is the highest that metric has been since March of 2005.

What’s unusual is that stocks have gotten more expensive in terms of valuation, even as the market itself has been relatively stagnant: The S&P has logged only mild losses on the year through Friday’s close.

The CNBC article notes that much of the expected decline in earnings comes from the energy sector but those stocks have also taken a beating as oil prices have fallen. It would appear that fundamentals are predicting a market correction. Our question is how can you profit from an overpriced stock market?

Take a Little Profit

If you have been in the stock market since it started to recover you have likely had a nice ride. One way to profit from an overpriced stock market is to take a little profit before the market corrects. Then you can hold on to your cash until such a correction happens and step back in to pick up a few bargains. Reuters reports profit taking in the gold market as traders anticipate the EU stimulus program.

The ECB is poised to announce a plan on Thursday to buy government bonds, resorting to its last big policy tool for breathing life into the flagging euro zone economy and fending off deflation. The stimulus measures should increase demand for bullion, but investors are cautious about the impact of such a move on the euro and the dollar.

One view is that if you really want to profit from an overpriced stock market you ought to take a  little profit and hold on to a little cash.

Other Options

An article in The Street remarks on how stock market volatility appears to be here to stay.

The volatility in the stock market this year is simply incredible. We have been expecting this volatility and it appears that it is here to stay. In addition, this stock market has no memory from day to day.

After being up more than 200 points on Thursday, the DJIA lost 141.38 points on Friday to close at 17,672.60. The S&P 500 was down 11.33 points to finish at 2,051.82. The Nasdaq was higher by 7.48 to close at 4,757.88 while the Russell 2000 was down 1.44 to close at 1,188.93.

It seems that the global, unelected central planners are intent on keeping this manipulated stock market bubble growing bigger and bigger. When this bubble will pop is anyone’s guess, but it appears that we are near the end of the rainbow.

Volatility is often seen at the end of market rally before the correction, or crash. A time honored method of dealing with such a market is to buy put options on stocks. You may believe that the market has way to go before it corrects and thus you may not want to miss out on more profits. But you also may be getting anxious. You can profit from an overpriced market by purchasing puts. These stock options give you the right to sell at the contract price which is at or near the current stock price even if the market collapses. But you keep the stock if the market continues to rise simply using the put contract as a little insurance.

Profit from an Overpriced Stock Market DOC

Profit from an Overpriced Stock Market PDF

Profit from an Overpriced Stock Market PPT

More Resources