Want to protect your profits, or against the uncertainty of a Bitcoin crash? Read on!
If you’ve been trading Cryptocurrency for a while, you may have heard Bitcoin Options mentioned many times. You might also have performed cursory research into what Options are and how to trade them but were put off because of confusing terminology or a lack of confidence to get started.
Maybe you thought: “Hah! Options, that’s what big institutions use; it’s no use for me and the amount of Bitcoin I have!”
Thanks to the awesome team over at Deribit, they have made Options extremely easy to access for retail investors and smaller account holders, they have no onerous restrictions to signing up, depositing some funds to get started, and have an enviable reputation for integrity and innovation. 3Commas, coupled with Deribit, opens the world of Options trading to everyone!
Take a moment to read this blog post, and maybe we can show you a real use of Options that you can take advantage of to protect the Bitcoin you are HODL’ing or are actively trading during this early bull cycle. We’ll show you how to hedge, which can be thought of as a cheap insurance policy to protect any of your profits or guard against rapid depreciation of any Bitcoin you are holding as a long term investment, should the market turn down or experience a sharp correction, in short, who wouldn’t want to have their cake and eat it?
Bitcoin has started a bull cycle and has recently closed a monthly candle above the previous all-time high set in December 2017. If you are investing, you will be holding your Bitcoin for some time, looking to sell it, or start taking profits at a much higher price than today.
Alternatively, if you are an active trader, you may be aggressively trading the uptrend, making frequent profits and possibly compounding gains into subsequent trades.
This blog post is not intended to cover all the details of how Options work, but to offer a real-world trade example of when and why you would want to use Options; there are additional links at the bottom of this article for other blog posts that explore and explain what Options are, their history and how they work.
Bitcoin/USD monthly chart showing a close at a new “All-Time High”
However, in the back of your mind, you’ll be thinking, “charts don’t keep going up,” and you know that at some point, the trend will reverse or a massive correction will occur, like the massive -37% drop (wicks excluded) that occurred in March 2020 could happen again. In fact, Bitcoin has a history of performing 30–40% corrections in previous bull cycles throughout its history.
Bitcoin/USD weekly chart with an example of the last major correction
So what is “hedging”?
Simply put, it is a way of protecting oneself against financial loss or other adverse circumstances.
For example, when you buy and hold Bitcoin, you are automatically in a Long position with the Bitcoin, as you buy it in anticipation of prices increasing. Wouldn’t it be great if, at the same time, you can also use a portion of your funds to help protect your investment in Bitcoin should the price fall?
This is one of the many benefits of Options.
Each trade should start with an objective or trade plan.
This needn’t be massively complex but allows you to set your objective, calculate your risk and identify key areas where you will need to manage your trade, so regardless of how the market behaves, you’ll already know the actions you will need to take.
Let’s assume you have 0.25 BTC purchased at an average price of $17,000 and cost you $4,250. This can either be a long term investment you made or profits from your trading.
Long term, you are bullish on Bitcoin and expect the price to far exceed $20,000, however Bitcoin has seen some resistance breaking $20,000, and you are unsure if a price correction will occur before Bitcoin breaks out and establishes support above the $20,000 price level.
Ultimately, you would only consider selling your Bitcoin above $30,000, and this is your long term target.
Looking at the Bitcoin/USD chart, we can see:
- The current chart price of Bitcoin is currently around $19,000, and a -30% correction from this price level would be a drop to approximately $13,300;
- On the weekly chart, Bitcoin may make a “double top” and get rejected at this price level;
- A big support level on the weekly chart (approx $11,500-$12,100);
- Arguably a weaker support level ($13,700-$13,900);
- Also, the 21-week Moving Average (white line), an area where price does tend to pull back to during bull cycles, and a projection where it may be in 2 weeks’ time using the current trajectory (approx $13,600)
We can see that there is a strong case for at least a short-term bearish scenario that could play out.
Creating the Options Bot
Let’s head over to the Options Bot interface by choosing it from the main menu in 3Commas (1) and selecting the Bot Creation (2) interface.
The Options Bot interface is simple and clean to use. You select your Deribit exchange account, Trade Currency, and Options contract Expiry Date (3).
The Options contract Expiry Date is important, as at the end of this date, the trade is settled, either in profit or loss. The Expiry Date should be set far enough into the future to cover your expected drop in price, should this occur. If the Bitcoin price is within the red area on the graph (6) displayed when the contract expires, you will lose the funds you have risked for the trade.
The Options Strategy (4) is the type of trade being configured. For this example trade plan, we are using a Long Put, which allows you to define the exact amount of funds to risk should Bitcoin price rise but provide uncapped profit potential should price fall. We are also using the Simple user interface as we will let the Options Bot calculate the underlying variables for this trade. You can hover your mouse or touch points on the graph (6) to view the profit or loss for your trade at specific price levels.
The Expected Trend (5) allows you to choose how aggressive this strategy will be by altering the risk to reward ratio of the trade. As our original purchase price of the Bitcoin we hold was $17,000, we can use this as an anchor point of our trade and set the break-even point to this figure by sliding the Expected Trend (5) control.
Max Loss (5) we can input the fixed maximum loss for this trade and model how this affects our potential profit from a successful trade.
We already have a target in mind of $13,000 to $14,000, and by calculating the loss of holding the 0.25 BTC bought at $17,000 — if the price fell and we were to do nothing, we can see this would be approximately $1,275. So we are looking to find the amount of funds to risk but also the reward (profit) of the trade that will cover the potential $1,275 loss from just holding onto our Bitcoin. Here is an animation of how you can work out the optimal values for this trade:
We can see in the animation above that a risk of 0.02 BTC, approximately 8% of your 0.25 BTC, would allow us to easily hedge against a -30% drop in price plus potentially make a profit on top!
Once you have found the settings to suit your trade plan, you can click the Create button to place the trade on the Deribit exchange and start the bot.
Managing your Options Bot
Click the Options Bot (1) from the main menu strip, and then click Active Bot (2).
You’ll see any Options Bots you have running here and can view the current status of your position (3), from the current profit or loss of the position, the time left until expiry of the contract being traded, and also a summary of the trade settings you configured.
The Chart button will show the graph of the projected profit or loss of the position, the current chart price of the contract is the reference point, and the graph displays the nearest price levels on either side of the current price.
You are also able to Market Sell this position to close it at any time for the current profit or loss displayed on the trade status indicator. Typically you would only do this if you are monitoring the chart price, and your TA (Technical Analysis) of the chart indicates that price may reverse and make the current trade unprofitable.
The Options Bot will automatically close and settle the trade once the expiry date of the contract is reached:
So, to summarise, if Bitcoin rises above $30,000 (your long term target), your 0.25 BTC would be worth $7,500 or a lot more if the more outlandish price predictions of $100,000 or more per Bitcoin were to happen.
If you were not using Options and set a traditional Stop Loss on your Bitcoin to sell it at your break-even price of $17,000, then you run the real risk of not being able to buy the Bitcoin back for less than you originally bought it for, particularly in the case that price quickly fell, activated your Stop Loss and then reversed a “bear trap.”
Using Options is the key for you; you get to keep most of your Bitcoin investment and at the same time insure yourself against the downside risk of a major price correction, without having the stress of selling your Bitcoin and then trying to buy it back at a lower price.
If the price does have a major correction to $13,000 or $14,000, with your Options trade, you will counterbalance the risk to your original investment by accumulating more Bitcoin as the price falls. If the price doesn’t fall and Bitcoin rises and holds above $20,000, your loss is capped to the amount of funds you specified as the risk for this trade, $360, but ultimately, your remaining 0.23 BTC investment will still be worth more than you originally paid for it.
By using the powerful 3Commas Options Bot, you can quickly and easily run through many possible scenarios to find the perfect balance of risk and reward for your trade, with only a few mouse clicks.
Further reading on Options
Warning: Trading on Futures exchanges is inherently risky, and while the rewards are great, so are the risks. If the price of the contract you are trading falls dramatically, you can be liquidated and lose your funds.