Option Strategy: A Kind of Hybrid Cash Covered Puts

Introduction

Options become a hot topic in crypto. Volumes are skyrocketing on Deribit and new initiatives have flourished in the DeFi ecosystem.

But what if I told you, you can buy Bitcoin at a lower pre determined price than the current market price and get paid to wait for that to happen?

Would you do it?

Today we explain: A kind of hybrid cash covered puts strategy

For those with no knowledge on options, we advise you to read our first article dedicated to strategies to short ETH via futures or options, here. We explain briefly what are options with few examples.

We have also discussed covered calls, here.

What is a Cash Covered Put?

A cash covered put is an option strategy where you are required to hold a cash position to buy the underlying asset (BTC or ETH) on which you sell (write) put options if it goes lower than a pre determined price (the strike price) in the future (at the expiry date).

You are selling an insurance that the BTC price will not move lower than a pre determined price.

If it goes lower than the price you have defined, you are happy to buy BTC at the strike price.

Let’s take an example: Bitcoin is at $9,200. You find it too expensive and want to buy it at $7,100 because you are convinced one Bitcoin is not worth more than $7,100.

Why?

Because Floyd told you so for weeks.

So you sell (write) a put option with a strike price at $7,100 with an expiry date on July 31, 2020. Actually, with a strike price of $7,000 (the closest strike available on Deribit).

And you get paid to wait for that to happen before July 31.

First of all, I have to say that you cannot execute a “classic” cash covered put strategy, like you would do in the stock market because Deribit does not currently permit to hold cash or stablecoins on their exchange, only BTC or ETH is allowed. So you cannot execute a “classic” cash covered put strategy but there is a subterfuge. I explain the process.

Requirements to execute this strategy

  • Holding a short position via futures contract with 1x leverage, equivalent to holding a synthetic USD position.

  • Sell/write BTC puts.

  • BTC current price: $9,200.

  • Put option taken into account: BTC $7,000, 31 July 2020, sold on Deribit.

  • Premium collected: 0.0125 BTC or ~$115.

Let’s explain the strategy.

To make the example as straight forward as possible:

  1. You send 1 BTC worth $9,200 USD to Deribit and you open a short position on the Futures contract with 1x leverage (no leverage) so you are holding an equivalent synthetic USD for $9,200 USD.

  2. You sell/write the put option with a strike price of $7,000 and expiry date on July 31, 2020. You collect a premium of $109-123 USD today to sell your put option, depending on if you are in a hurry (taking the bid price ) or can wait a bit for a greedy bear to buy your ask.

Starting capital: 1 BTC, worth $9,200 USD.

NB1: It is important to understand that taking a short position on the futures contract with 1x leverage will protect your dollar amount but not your BTC amount in case BTC goes up in USD value. You can find more information from Deribit Insights on long synthetic USD, here.

NB2: Holding a synthetic long USD even without leverage is more risky than holding spot BTC.

Possible outputs

#1 - Bitcoin ends up higher than $7,000 at expiry date

Bitcoin ends up at $7,516.

In this case, the price at expiry is higher than the strike price so your counterparty does not execute his put option. Indeed, why would someone sell Bitcoin at $7,000 USD if it can be sold at a higher price (ie $7,500) in the market?

You counterparty only exercises his put option if the market price is lower than the strike price.

You keep the premium collected (0.0125 BTC or $93.83 USD).

  • At trade initiation, you had $9,200 USD (1 BTC equivalent) and the premium collected (0.0125 BTC or ~$115), so a total of $9,315 USD.

  • On expiry date, the put option expires worthless and you close your synthetic USD with 1x leverage. You still holds an equivalent of $9,200 USD or approximately 1.23 BTC (thanks to your short futures position). And you also keep the premium collected (0.0125 BTC). Total 1.2425 BTC ($9,338 USD).

Return: 1.5% in USD / 24% in BTC.

#2 - Bitcoin ends up lower than $7,000 at expiry date

Bitcoin ends up at $6,507.

In this case, the price at expiry is lower than the strike price so your counterparty does execute his put option. You owe him or her, some of your BTC.

You still keep the premium collected (0.0125 BTC or $81.33 USD).

  • At trade initiation, you had $9,200 USD (1 BTC equivalent) and the premium collected (0.0125 BTC or ~$115), so a total of $9,315 USD.

  • On expiry date, the put option expires ITM (in the money, strike price > market price for put options) and you close your synthetic USD with 1x leverage. You still holds an equivalent of $9,200 USD or approximately ~1.41 BTC (thanks to your short futures position). And you also keep the premium collected ($0.0125 or $81.33 USD).

  • However, you owe your counterparty some of your BTC (~0.06 BTC) as the market price at expiry is lower than the strike price.

  • On expiry date, you have a total of ~1.356 BTC ($8,823 USD).

Return: -4% in USD and 35.6% in BTC.

#3 - Bitcoin ends up higher than 9200 at expiry

Bitcoin ends up at $10,000.

In this case, the price at expiry is higher than the strike price so your counterparty does not execute his put option. Indeed, why would someone sell Bitcoin at $7,000 USD if it can be sold at $10,000 in the market?

You keep the premium collected (0.0125 BTC or $125 USD).

  • At trade initiation, you had 1 BTC ($9,200 USD equivalent) and the premium collected ($115 or 0.0125 BTC), so a total of $9,315 USD.

  • On expiry date, the put option expires worthless but your short position cost you ~0.08 BTC. You hold 0.92 BTC + the premium 0.0125 BTC for a total of 0.9325 BTC or an equivalent of $9,325 USD.

Return: 1.3% in USD and -6.75% in BTC.

If BTC went to $12,000 USD, you would have a total of 0.7775 BTC or an equivalent of $9,330 USD.

Key takeaways

We describe a kind of hybrid cash covered put strategy applied to Bitcoin. Indeed “classic” cash covered puts cannot be implemented as Deribit relies on BTC deposits and does not allow USD or stablecoins deposit.

To get over this issue, we propose to rely on a synthetic USD position via a short futures position with 1x leverage.

By doing that, you can still implement a kind of cash covered put strategy.

We do like covered options strategies because we can generate a yield and get paid to wait for Bitcoin to reach a pre determined price. In cash covered puts, you wait to buy Bitcoin at a lower price than the current market price. In covered calls strategy, you get paid to wait to sell Bitcoin at a higher price than the current market price.

These option strategies are hard to understand at first but options offer great opportunities to generate yield, speculate or hedge positions and do have a great utility for all traders.

For those of you who will start playing with the position builder, keep in mind that it tracks the PNL of the open position itself.

For everything related to options, we do recommend to use Deribit. They are transparent and the most liquid exchange for options trading on BTC and ETH. If you use our ref link, you will get a 10% discount on fees paid.

Click here

Thanks for reading

Secret Salsa


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