Trading Tutorial 1: Hedging with Collars
Protect your holdings and retain some upside
With BTC and ETH at depressed levels, many are looking to protect further downside on their holdings but are also expecting a bounce as we head into the end of the year (2nd week of September was the low for 2017 before the crazy bull run). A strategy that allows you to do this is a Collar Strategy.
This strategy involves buying a put option to protect downside and selling a call option to offset the cost of the downside protection. This strategy is especially appealing right now because call options are more expensive than puts which allows you to maximise your upside for a given downside protection in multiples.
Example with options:
With ETHUSD at 245 (at time of writing), buying a put option with a 200 ETHUSD strike level (means you are protected below 200 ETHUSD) costs 55 USD per ETH. Selling a call option with a 300 ETHUSD strike level (which means your upside is capped above 300) will give you 50 USD per ETH. Putting on this structure will cost you 5 USD per ETH and will last till end of March 2019.
This strategy will protect you if ETHUSD goes below 200 and allow you to profit from ETHUSD upside to the 300 level. The whole structure will cost you 5 USD per ETH, and the risk-reward ratio is 1:1.2; you limit yourself to a 45 USD downside for a 55 USD profit upside.
However, many projects need to cash out for working capital which makes using options impractical. We can solve this easily by replicating the payoff profile of the Collar strategy by using a combination of stop-loss and limit orders around the chosen strikes. This synthetic Collar strategy method would entail zero cost and allow you to cash out for working capital.
This is part 1 of QCP’s Trading Tutorial series, check out part 2 here.
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