OKEx Crypto Options Principles and Strategies II: Straddle and Strangle

OKEx
OKEx
Jan 9 · 5 min read

With the soft start of knowledge sharing and introduction to our new product, we have prepared this second episode of the series for you to explore options volatility strategies.

I. Volatility

As widely known, and yes, “notorious”, crypto market’s volatility is super high and even hard to play with in certain times, such as market events and breaking news. Back in late 2008, there was short-lived high volatility in the US stock market during the financial crisis, which was topped as 65%, and the crypto market experiences this almost every day. Market participants may love or hate this swing, rise and fall. As such, it is worth looking into what volatility is, rather than keeping it in a cage as a roaring, fearful beast.

Volatility, in the mathematical terms which we may have heard at school, is defined like this:

Many details are omitted here, however, we need to point out what it means is that volatility is a financial measure for how far log-return of a financial instrument (e.g. BTC) is dispersed from average. So, if the volatility is high, this means the price goes up and down significantly within a given time period. In addition, there is a certain assumption on the price distributions to describe the real market, and different kinds of volatility exist, such as implied volatility, which takes the market price of options. In this article, we will dig deeper into volatility and look at volatility surface and smiles.

II. How volatility can be used?

At the time of market fluctuation, aka a highly volatile market, users can consider implementing these two strategies on our options market.

1. Straddles

A straddle is a strategy buying a call and a put of the same strike price and expiry date.

For example, given the current price of the underlying, BTC Spot, is $7,500. You forecast the BTC price will undergo severe volatility with upcoming events, but are not sure about whether it will go up or down. So you decide to implement an options straddle strategy, by buying both call and put BTC options, strikes at $7,500, which will expire in 7 days, and pay the option premium, $207 and $206, respectively.

Case1. After the event, the market moves down to $6,900 and the options expire. What will your final PnL be?

  • The call becomes out-of-the-money (OTM), you lose the call options premium, $207. However, the put option settles with a profit of $600. So the final PnL is $187 (= 600–207–206), which is a good and neutral trade.

Case2. After the event, the market jumps up to $8,000 and the options expire.

  • In this case, the put becomes moneyless. However, the call option generated a profit of $500. Thus, the overall PnL is $87 (= 500–207–206), and you are safe from the market fluctuation.

Case3. Even after the event, the market is not affected significantly. On the expiry date, BTC spot is traded at 7,700. What will your PnL be?

  • The call options will be settled with $200 profit, and the put will become moneyless. Thus, the final PnL is -$213 (:=200–207–206), which is a loss.

So then, what if you predict the market would not move that much?

You can opt for a short straddle strategy, by selling both call and put options of the same strikes and expiry. Thus, in the Case 3 scenario, the PnL would be $213 (= 207 + 206–200), which is profit, secured by collecting the options premiums.

2. Strangles

The above trading strategies and examples illustrate how you can play on volatilities. However, buying both call and put may be pricey. So, here we put together a cheaper market-neutral strategy than the above one.

A strangle is a strategy of buying a call and a put of the same expiry date, but different strike prices.

Let’s look into it with a similar example. Given the current price of the underlying, BTC Spot, is $7,500, and your forecast the price and direction are as same as the above example. You considered straddle but it is expensive to implement, so you are now going for a put strangle strategy, by buying a $7,800 strike call and a $7,200 strike put BTC options, expiring in 7 days. You pay options premiums $100 and $70 respectively.

Case1. On the expiry date, the market moves sharply, down to $6,900 and the options expire. What will your final PnL be?

  • The call becomes out-of-the-money (OTM) and you lose your call options premium, but this time $100, less than that of the straddle. Plus, the put ends with a profit of $300. So, the final PnL is $130 (= 300–100–70). You’ll get less profit compared to the straddle, but remember, it is less risky and the ROI is higher.

Case2. Same situation, the market jumps up to $8,000 and the options expire.

  • The put becomes moneyless, and the call earns $200. Thus, the overall PnL is $30 (= 200–100–70).

Case3. Even after the event, the market is not affected significantly. On the expiry date, BTC spot is traded at 7,700. What will your PnL be?

  • In this situation, both the call and the put are moneyless. Thus, the final PnL is -$170 (= 0–100–70), which is a loss, but relatively small.

You may also consider the short strategy as we considered before.


Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involves significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.


OKEx Blog

World’s Largest Spot & Futures Cryptocurrency Exchange

OKEx

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OKEx

Buy & sell Bitcoin, Ethereum and more at the world’s largest spot & futures cryptocurrency exchange. http://www.okex.com

OKEx Blog

OKEx Blog

World’s Largest Spot & Futures Cryptocurrency Exchange

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