Bitcoin seems to be struggling at the $58,000 level, which is leading some traders to fear a more significant correction could take place.
While Bitcoin’s (BTC) 2021 performance has been incredibly strong, its current 696% gain and comments from United States Treasury Secretary Janet Yellen suggesting that cryptocurrencies are used to finance terrorism may be enough to have investors feeling a bit cautious.
Reducing open position sizes is usually the method most investors use to reduce exposure, but another way to manage risk is to use BTC options contracts to provide protection. Buying a put (sell) option is the easiest way, but it is quite costly considering the current high volatility scenario.
For example, a March 26 put option with a $56,000 strike trades at $5,300, and its holder would only profit if BTC trades below $50,700 in 32 days. That would be 12% below the current $57,500 price. This protection cost depends on the number of days until expiry and the implied volatility, or a traders’ expectation of substantial price swings.
By using call (buy) options and puts (sell), a trader can create strategies to reduce this cost. There are infinite possibilities, but for now, let’s focus on a low-cost bearish one.
Protective puts can generate a profit on the downside
This bearish strategy consists of buying a protective put in order to profit from the downside while simultaneously selling call options at higher strikes. These additional trades will cover the put option’s cost but will result in losses if BTC surpasses a certain threshold.
Profit / Loss estimate. Source: Deribit Position Builder
The above trade consists of buying 1 BTC contract of the March 26 put option with a $56,000 strike, while selling 1 BTC contract of the March 26 call option with a $64,000 strike.
As the estimate above shows, the end result between $56,000 and $64,000 is neutral. The trader would not incur any losses, but would also not profit from the strategy. On the other hand, if BTC drops to $46,000, or by more than 20% from $57,500, the contract holder would profit by $10,200.
In order for the trader to incur a $5,000 loss, BTC would have to reach $69,000 on March 26, which is equivalent to a 20% gain from the current price. Therefore, even though 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 downside protection. Moreover, there is zero upfront involved for those trades, except from the margin or collateral deposit requirements.
author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research when making a decision.