A Bitcoin Trade, But Safer
Cryptocurrencies are a wonderful investment opportunity, at least for some investors. The key to investing in cryptocurrencies could well be the ability to tolerate extreme levels of volatility. For traders, volatility is another word for risk and the risk is high in cryptocurrencies.
Bitcoin is just one of the thousands of cryptocurrencies available in the market, but it is the largest and most liquid crypto and provides insight into the state of the broad market. Futures are available, and bitcoin and the chart below shows the extreme volatility of the futures.
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Prices have been volatile on both the up side and down side. Many traders would like to target the quadruple digit gains that are possible in the markets but are uncomfortable with the high risk that comes with those kind of returns.
Some stocks offer an indirect way to trade cryptos. Among those is Square Inc. (NYSE: SQ).
The stock surged higher earlier this week “after an obscure website in Latvia called Cryptona published a report claiming Square is ‘possibly testing an integration with Bitcoin.’”
This is actually old news that accounted for the spike high in the stock seen last November. At that time, Square began testing the use of Bitcoin.
The company announced that this was being done to meet customer demand.
“We’re always listening to our customers and we’ve found that they are interested in using the Cash app to buy Bitcoin,” a Square spokesperson said in a statement, reported on by TechCrunch. “We’re exploring how Square can make this experience faster and easier, and have rolled out this feature to a small number of Cash app customers.”
According to TechCrunch, the trial uses a very basic interface. Customers wishing to access it must swipe right from the Cash Card page. Once there, they are presented with both a U.S. dollars and Bitcoin balance, buy and sell buttons and a graph showing performance over the last day, month or year.
After the news, the stock sold off as Square expanded the functionality. Now, recycling the news created another surge in the stock. The latest move increased volatility and options premiums.
This presents a possible trading opportunity. Knowing premiums are elevated, strategies that sell options could be attractive. However, there is no way to forecast the directional bias of the expected price move.
This means a trader might not know whether it is best to use a strategy that involves selling puts of calls. There are options strategies designed to benefit from volatility even if the trader is unwilling to take a position on the direction of the volatility.
A Strategy to Benefit While Waiting for More Details
As we wait for more details on the company’s plans related to the crypto markets, we could see stocks settle into a trading range. One options strategy that benefits from a stock in a trading range is an iron condor. This strategy has the added benefit of carrying limited risk.
To open an iron condor trade, the investor sells one call while buying another call with a higher exercise price and sells one put while buying another put with a lower exercise price. Typically, the exercise prices of the calls are above the market price of the stock and the exercise prices of the put options are below the current price of the underlying stock.
In an iron condor, the difference between the exercise prices of the two call options will be equal to the difference between the exercise prices of the two put options. The final requirement for this strategy is that all of the options must have the same expiration date.
The risks and potential rewards of the strategy are shown in the following diagram.
Source: The Options Industry Council
The maximum gain on this trade is equal to the premiums received when the position is open. The maximum risk is equal to the difference in the two exercise prices less the amount of the premium received when the trade was opened.
Opening an Iron Condor in Square
For Square, the trade can be opened using the following four options contracts:
As you see, all of the options expire on the same day, Friday, March 16.
The difference in the exercise prices of the calls or puts is equal to $1.00. Since each contract covers 100 shares of stock, this means the maximum risk on the trade is equal to $100 less the premium received when the trade was opened.
Selling the options will generate $1.04 in income ($0.40 from the call and $0.64 from the put). Buying the options will cost $0.76 ($0.31 for the call and $0.45 for the put). This means opening the trade will result in a credit of $0.28, or $28 for each contract since each contract covers 100 shares.
The maximum risk on the trade is equal to the difference in strike prices ($1.00) minus the premium received ($0.28). This is equal to $0.72, or $72 since each contract covers 100 shares. Many brokers will require a margin deposit equal to the amount of risk. That means this trade may require just $72 in capital.
The maximum gain on the trade is the amount of premium received when the trade is opened. In this case, that is $0.28 or $28 per contract.
The potential reward on the trade ($28) is about 38.9% of the amount risked, a high potential return on investment for a trade that will be open for about one week. If a trade like this is entered every month, a small trader could quickly increase the amount of capital in their trading account.
This trade could also be closed out early to reduce the potential risks of the trade. It could still deliver its maximum gain even if the position is closed before the expiration date of the options.
The iron condor is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide income and defined risk that should be lower than owning the stock.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.