Low Risk Bitcoin Trade
Bitcoin and the cryptocurrency craze seems to be showing signs of cracking. From a high near $20,000, bitcoin dropped below $10,000 this week. While the direction of the next price trend is unclear, traders can be almost certain that the volatility in crypto currencies will continue.
Volatility, in this case, will be partly driven by buyers who got into the currencies after large run ups. The last six months saw bitcoin trade from a low of $2,491 to a high of $19,187. Volume surged when the prices came off the high as new traders thought of the decline as a buying opportunity.
Now, the traders who entered the market after the peak are sitting on losses. Some will add to their positions by buying more. Others will cut their losses by selling. This will lead to volatility. The direction of the trend will be determined as it is in all freely traded markets, by whether the buyers or sellers are more aggressive.
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Bitcoin Futures Highlight a Low Risk Trade
Derivatives on bitcoin in the form of futures contracts began trading on the Cboe on December 10. Since then, contracts have been introduced on another exchange, the CME. These futures open a number of trading strategies for traders.
One popular strategy among futures traders is to consider intermarket relationships and make trades based on expected patterns that form in different markets. For example, many traders find that they can profit from the fact when bonds fall in price, stocks tend to fall as well.
This relationship is based on the fact that when bonds fall, interest rates rise. Higher rates provide investors with an alternative to the stock market and a decline in bond prices could signal a decline in the stock market.
These relationships are not exact but can provide general ideas for trading strategies, especially if the relationship can be confirmed with other reasons to consider a trade.
With bitcoin, there seems to be an inverse relationship with the price of gold. This is shown in the chart below.
Gold and Bitcoin Share a Purpose
Both gold and bitcoins could be viewed as alternatives to the dollar. Both can be considered as a store of value or a safe haven in times of turmoil. Reports from Venezuela and other high inflation countries indicates individuals have turned to bitcoin as they turned to gold in past crises.
The inverse relationship indicates that as bitcoin falls, we should expect the price of gold to rise. This creates a trading opportunity. Instead of directly trading gold, we will use the SPDR Gold Shares (NYSE: GLD) ETF.
An ETF is an exchange traded fund. The manager of the fund pools the money of individual investors to invest in line with the objectives of the fund. In the case of GLD, the manager buys gold. That creates a tax concern for some investors since gold and shares of GLD are taxed as collectibles and require additional forms for reporting.
Using options simplifies the taxes for obtaining exposure to gold and has several other advantages.
A Trade for Short Term Bulls
As with the ownership of any stock, buying GLD could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
A Specific Trade for GLD
For GLD, the February 2 options allow a trader to gain exposure to the stock.
A February 2 $127 call option can be bought for about $1.10 and the February 2 $129 call could be sold for about $0.45. This trade would cost $0.65 to open, or $65 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $65.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in GLD the maximum gain is $1.35 ($129 – $127 = $2.00; $2.00 – $0.65 = $1.35). This represents $135 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $65 to open this trade.
That is a potential gain of about 108% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in stock trading tips Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.