The Federal Reserve The Federal Reserve is increasing interest rates at their highest rate in almost 30 years. With inflation at an all-time high and a looming recession, protecting capital is at the forefront of every investor’s mind.
While cash and government bonds were once considered safe assets in bear markets, inflation is now rampant and central banks are struggling to stabilize yield curves. These traditional safe havens look less safe.
Options contracts are a great way to hedge your risks. They give you the option, but not the obligation to, to trade assets in the future at a fixed price. A call option is the option to buy and a option to sell is the option to sell.
There are two types options contracts. American-style options permit traders to exercise their options at any time during the contract’s life, while European-style options cannot be exercised after its expiry date.
You can either let your put or call option expire, or you can take no action if it’s not financially profitable. This scenario will limit your costs to the price you paid for the options contract at the time it was purchased.
Multiple trading strategies use options contracts. But in this article, I’d like to share some approachable strategies that allow a certain amount of protection without needing to sell your assets.
Let’s take Bitcoin as the underlying asset. A put option that has a strike price equal or greater than the current price gains value when Bitcoin falls lower.
If your Bitcoin is in red, your options contract should be green. If the market trend is higher and nullifies your option, Bitcoin will have appreciated covering some cost of the contract.
This strategy works best for traders who have Bitcoin as long-term investments but do not want to sell. This avoids the worst-case scenario of a cascading liquidation that would cause Bitcoin to plummet dramatically. It is similar to buying insurance for downside risks.
If you think the market will fall further, you can purchase a put option. This is a form of insurance that pays out if the market falls. Particularly in bear markets, timing is critical.
You might consider buying a put option if you feel the market will fall quickly. But if it falls slowly, the initial investment may not be worth it. The premium paid for the put option may not be recoverable. The same principle applies to calls options.
Selling call options, while still holding the underlying asset, is another popular use of options contracts. A call option can be sold to another party to get paid immediately. This gives them the right to purchase your Bitcoin if the price rises beyond a predetermined amount.
For example, if you sell a call option agreeing to sell 1 BTC at $30,000, you collect the price of that contract — the premium — right away, which acts as a hedge against the downside. You would lose out on any gains over the strike price. The option buyer would own that risk.
If Bitcoin doesn’t hit the strike price, then the option expires, and you keep the premium. This strategy comes with the risk of Bitcoin’s underlying value falling in the interim.
The bear market in crypto and other capital markets can be a time for capital protection. When the good times return, you will have plenty of opportunities to reallocate capital. In times of trouble, the Bitcoin price can whipsaw traders. You can build a stronger portfolio without having to HODL your Bitcoin stack.