How To Profit In A Sideways Market
Trading options are great for profiting from volatile price action while limiting risk. But they can also generate steady income during periods of low volatility or sideways price action.
Don’t know what options are? Read this article first.
Any views expressed below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.
How does time-decay affect the price of an option?
Theta (Θ), also known as time-decay, is the dollar amount that the option’s price is expected to decrease per day throughout the option’s lifespan. As expiration nears, the value of theta increases and the value of the option decreases because the time limit left to profit from the option decreases.
As an option buyer, you’re fighting against theta and as an option seller, theta is working for you because sellers profit from options expiring worthless.
So how do we make money from time-decay?
I’ll be covering two neutral strategies below:
1) Iron Butterfly
This is a multi-legged option strategy consisting of 4 options (2 puts and 2 calls).
Steps:
- Sell an at-the-money or out-of-the-money put and a call with the same strike price.
- Buy an out-of-the-money put and call.
You’re expecting the price to move sideways and expire at the strike price of the put and call sold. The out-of-the-money put and out-of-the-money call will act as insurance for our trade to help reduce any losses.
For example, Bitcoin is trading at $20,875 and a trader wants to execute the Iron Butterfly strategy on the June 26th expiration.
- They sell the 20500 call receiving a credit of $616.20 and sell a put with the same strike price receiving a credit of $229.80 for a total of $846.00.
- They also buy the 22000 call for $73.10 and the 19000 put for $41.80 paying a total of $114.90.
The net result is a $731.10 credit received after the total price paid for the options bought is subtracted from the credit received from the options sold ($846.00–$114.90).
- Amount received for selling the call and put = $616.20 + $229.80 = $846.00
- Amount spent for buying call and put = $73.10 + $41.80 = $114.90
- $846.00–$114.90= $731.10 initial net credit
Max Profit:
The credit received ($731.10) is the maximum profit the trader can make and occurs when all of the options expire worthless. This will happen if the price of Bitcoin is at $20,500 on June 26th.
Break-even:
There are two break-even points which are calculated by the following formulas:
Upper break-even price: strike price of the call sold + net premium received = 20,500+846 = $21,346
Lower break-even price: strike price of put sold-premium received = 20,500-846 = $19,654
If the price of Bitcoin is at either of these two prices on the date of expiration (June 26th) then the trader will break even. If the price is higher than $21,363 or lower than $19,654 then the trader can incur a loss.
2) Iron Condor
Similar to the iron butterfly, the iron condor is also a multi-legged option strategy but instead, the trader sells a put and a call at different strike prices creating an upper and lower bound for the price to fluctuate within.
Steps:
- Sell an in-the-money put and in-the-money call at different strike prices.
- Buy an out-of-the-money put and out-of-the-money call.
You’re expecting the price to move sideways and expire between the strike prices of the put and the call sold. The out-of-the-money put and out-of-the-money call will act as insurance for our trade to help reduce any losses.
For example, Bitcoin is trading at $20,875 and a trader wants to execute the iron condor strategy on the June 26th expiration.
- They sell the 20000 call receiving a credit of $1,324.10 and sell the 21000 put receiving a credit of $458.70 for a total of $1,782.80.
- They also buy the 21500 call for $156.40 and the 19500 put for $73.00 paying a total of $229.4.
The net result is a $1,553.40 credit after the total price paid for the options bought is subtracted from the credit received from the options sold ($1,782.80-$229.40).
- Amount received for selling the call and put = $1324.10 + $458.70= $1,782.80
- Amount spent for buying call and put = $156.40 + $73.00 = $229.40
- $1,782.80 - $229.40= $1,553.40 initial net credit
Max Profit:
The credit received is the maximum profit the trader can make and they get to keep it when all of the options expire worthless. This will occur if the price of Bitcoin is between $20,000 and $21,000 at the date of expiration (June 26th).
Break-even:
There are two break-even points which are calculated by the following formulas:
Upper break-even price: strike price of the call sold + net premium received = 20,000+1782.80 = $21,782.80
Lower break-even price: strike price of put sold-net premium received = 21,000-1782.80= $19,217.20
If the price of Bitcoin is at either of these two prices on the date of expiration (June 26th) then the trader will break even. If the price is higher than $21,782.80 or lower than $19,217.20 then the trader can incur a loss.
Conclusion
Both strategies can be profitable in times of low volatility and sideways price action. The iron condor is considered a lower risk, lower reward trade, while an iron butterfly is a higher risk, higher reward trade. Since the iron condor provides an upper and lower bound, the asset’s price at expiration can be within this range. On the other hand, an iron butterfly requires the asset to expire at a specific strike price to yield maximum profit.
Ready to trade options?
Deribit will soon be releasing the ability to trade multi-legged options on their platform in one single action. For now, traders who want to execute these strategies can do so by manually executing 4 consecutive trades. It is important to note that all legs of the trade need to be filled.
Sign up now and receive a 10% discount on fees.
Looking for an edge?
CoinOptionsTrack is a simple, and easy-to-use options analytics tool for new and advanced traders.
Real-time + historical options price data from Deribit
Beautifully displayed analytics
Open Interest across expirations and strikes
Max-pain price and more!
Check it out: https://www.coinoptionstrack.com/
