Hedging your crypto investments can protect your wealth from adverse price movements and also help you make significant profits even during bear trends. Hedging refers to investing in assets inversely related to the investment portfolio to limit losses and reduce uncertainty while the potential rate of return remains positive on the overall portfolio.
There are different hedging methods; each is usually a combination of a low-price option and a physical asset. Investors usually invest in an inversely-correlated crypto asset such that should the portfolio witness losses during adverse price movement; the correlated security will act as the hedge to cover such losses. Another great strategy is using hedging with put options to limit losses and reduce exposure to risk. Let’s figure out what put options are and explore the handy tips for utilizing Hedging with options.
How Do You Hedge Crypto With Options?
If you are a cryptocurrency investor and want to hedge your holdings against sudden price drops, then options may be the way to go. If you want to hedge your position against adverse price movements, you can buy calls or puts into creating a position of long-term or short-term until expiration.
Investors with a substantial long position on certain crypto may buy put options as downside protection. If the crypto price falls, the put option allows the investor to sell the crypto asset at a higher price than the spot market, thereby allowing them to recoup their losses.
How Do Put Options Work?
A put option allows crypto traders the right to sell (remember, not an obligation) an asset at a specified price within a predetermined time period. Crypto investors use put options as downside protection when they decide to go long. Options are tied to the performance of the underlying asset, in this case, a cryptocurrency. A trader need not own a crypto asset if they want to buy or sell the option tied to a particular crypto asset.
Put options allow traders and investors to cut their losses and preserve their initial investment by allowing them to sell off the crypto at a specified price before the price drops. While it may not be for everyone, the utility of put options should not be underestimated, and it’s important that investors understand all the risks involved before making a decision.
#1 Check out Option Pricing:
The price of a put option is primarily determined by the downside risk associated with the underlying asset. If investors believe that the crypto asset underlying the put option will be under-valued at the expiration date and time, they might buy a put option. The price of the put option is calculated by deducting an amount equal to its intrinsic value and subtracting the premium. The difference between these values determines what you pay for the options.
The seller of a put option receives a premium for the right to sell securities. It is based on how much the investor is willing to pay to reduce their risk. The greater an asset’s downside risk, or volatility, the more expensive an option that reflects that risk will be.
#2 Factors to look for:
We all know that the current crypto market is not that efficient or generous, so make sure to look for these three main factors while dealing with the expenses of any option strategy:
Volatility Premium: When dealing with security, you must know that implied volatility generally has a higher value than realized volatility. This means that investors end up paying more than they need to for protection against downside risks.
Index Drift: Asset indexes generally tend to go higher with time. This implies that with the value of your underline crypto going up, your put option value might suffer a decline.
Time Decay: Time date refers to the fact that your options can gradually lose some value as it moves toward the expiration date.
You can use Delta’s Option Analytics as it features several tools designed to help traders make better decisions when trading options. The main feature of Delta’s Option Analytics is its MOVE option feature, which mirrors an option strategy by combining a put option and a call option with the same strike price.
Delta’s Option Analytics provides traders with the ability to use historical data. From this data, traders can see the intraday and weekly volatility and the profits that previous investors generated. Delta’s Option Analytics also gives traders access to a special section to track most activity, including open, pending, executed and canceled orders.
#3 Use Put Options to Cancel out Short term price fluctuations
There are many ways to hedge risks and make investments work for you. One of the most reliable strategies for hedging the market fluctuations risk is purchasing long-term put options. Long-term put options can be thought of as a way to lock in profits from short-term fluctuations.
A strike price that is too high or too low may expose you to risks, including losing principal or even gaining on the position. This can ruin a long-term strategy and make it difficult to recoup what has been lost. Volatility, interest rate changes, and economic cycles must be considered when establishing investment goals and risk tolerance. However, while going for a long-term plan, always look for indexes with lower volatility.
#4 Consider the Strike Price and Expiration Date
Once you have made your choice for the put option, you need to consider two key elements: the expiration date and the strike price. For the uninitiated, strike price refers to the price at which traders exercise an option. Higher strike prices call for more expensive put options as the seller here is undertaking greater risk. In ideal circumstances, the purchase price of a put option will be equivalent to the downside risk of the underlying crypto asset. A trader should do their homework before determining the expected downside and, consequently, buying the put option.
Taking the expiration date or the timeframe of the put option into consideration, the closer the put option is to its expiry, the lesser value it will have, and vice versa.
#5 Determine Your Risk Profile Before Making a Choice
Whether put options are right depends on your risk tolerance and financial goals. For the most part, they can be a great investment vehicle, so long as you understand how they operate and don’t increase your risk beyond what’s sensible for your situation.
For instance, let’s say someone named Daniel purchases a Bitcoin put option that grants him the right to sell Bitcoin at $25,000 within the next year. Suppose Bitcoin is trading at $30,000, and Daniel has purchased this put option as a hedge against his Bitcoin holdings.
Now, if Bitcoin falls to $23,000 in the next 6 months, Daniel could have exercised his put option and sold his Bitcoin put option at $28,000 instead of the current market price of $23,000. His loss would be only $2,000, $5,000 less than the actual fall in prices.
Final Thoughts
As you can see, there are many different elements to hedge trading, and it’s worth taking the time to read up on the risks and benefits. Everyone has slightly different circumstances, so try various strategies and see what works best. But always be aware that if things start getting worse, you may need to rebalance your portfolio because if a crash causes your portfolio to lose 50% of its value, you could end up losing half of your entire investment!
In such cases, you can use Hedging strategies such as put options to minimize the impact of market movements and protect your investment from these fluctuations and possible losses.
