Risk Reversal Options Strategy in Crypto

Volatility is a real issue (or advantage perhaps? Depending on how you see it) in the crypto markets. Regardless, proper risk management is a must if you want to survive. The risk reversal options strategy in crypto is a pretty flexible one in this regard, and it can save your investments from decimation.  

How to use it, and what does a risk reversal options strategy entail? Before you bombard us with a truck full of questions, all answers are coming in due time, so sit tight and lend us your eyes. Here we go:  

What is a Risk Reversal Option Strategy?

Academia trains us to always learn definition first instead of a practical example that honestly makes things easier to understand, but who are we to break the age-old cycle?

Risk reverse is all about actively hedging your investments with crypto options contracts. For long positions, this involves selling calls (right to buy) and buying puts (right to sell), and for short positions, this involves the exact opposite. 

How Does a Risk Reversal Options Strategy Work?

Let’s simplify the mechanics of a risk reversal options strategy. We’ll take two scenarios.

Firstly, let’s assume trader A has a long position open in the crypto market. They can now use a short risk reversal option strategy to hedge this position. All trader A needs to do now is buy an out-of-the-money (OTM) put option (this means the strike price of the option is below the current market price of the underlying asset) and sell an out-of-the-money call option (strike price is above the current market price). Both options need to have the same date of expiry for this strategy to work out well.  

Now, any potential profits and losses will emerge out of market movements against or for the underlying long position. 

On the other hand, say trader B has a short position; they can put a long risk reversal options strategy to use. They have to sell a put and buy a call, so there’s a limit to the possible profits while any volatility-related risks to the aforementioned short position is taken care of. 

We know, we know, this sounds too complex. But trust us, it’s easier to execute than it sounds once you have gotten the hang of crypto options. 

Pros vs Cons of Risk Reversal Option Strategy in Crypto

So, is risk reverse with crypto options for you or not? What could be better than a pros and cons list to understand it:

Pros of Risk Reversal Options Strategy	Cons of Risk Reversal Options Strategy
Firstly, risk reverse helps you limit risks to your existing positions, which automatically makes it deserving of due consideration.	No doubt, risk reversal option strategy is a pretty complex thing to execute, and you can suffer severe losses if you don’t do your market research well enough. In one sentence: not safe for metaphorical toddlers to the world of crypto.
Plus, in a risk reversal options strategy, you can speculate on the upcoming prices for a certain crypto without risking a significant part of your funds. You can profit from the direction you expect the market to take in the short or long term without investing a lot of extra capital, or closing any positions you already have.	Multiple rounds of transaction costs for you to bear, comes with the multiple positions you’re opening to implement hedging in your portfolio. You don’t wager off a significant part of your savings, but it still adds up over time.
You can alter the strategy based on your risk appetite while having greater control over your exposure to the crypto market. You’re combining buying and selling crypto options, so you can take into account any short-term catalysts; for example, if you want to protect your investment against a potential price drop due to say a socio political event in the coming days, you can choose an option which will pay you when the market price drops below a certain level.	No more cons, the pros have won this match.

 

And there you have it, the advantages vs disadvantages of risk reversal options strategy. Don’t go just yet, there’s more!

How Does Risk Reversal Option Strategy Help Avoid Slippage?

The ‘slippage’ term arrives only because risk reverse in options is often countered with a stop loss/take profit order by many. In a stop loss order, you set a price point where your position is closed. Say you have a stop loss of $60,000 in a BTC long position right now. 

If the market moves too quickly and drops past your stop level before your stop loss can get activated, it might get fulfilled at around $59,500. The loss of $500 is your slippage.

A risk reversal options strategy does not have the same shortcoming- because it has a contractually set price over a fixed time period.  

Real Talk: How Can You Use a Risk Reversal Options Strategy?

We at Delta like practical examples instead of theoretical discussions, so here’s how you can execute a risk reversal option strategy:

• Bitcoin has a raging bull market going, so we’re going with our undisputed king for this example. Let’s take Bitcoin’s price as $71,000.
• Let’s say you want to long Bitcoin but fear the Bitcoin halving period may cause a slight price drop, so you need a short risk reversal options strategy. First, write a call, say with an expiration date of April 30, 2024, and with a strike price of $75,000. Next, buy a put, with the same date of expiry and a strike price of $69,000. 
• Now in the short term, if Bitcoin prices indeed fall, the call expires out of the money, and the put expires in the money. 

Note that we have taken these price points simply as references; in no realistic scenario do we believe the everyday trader can experiment with contracts at these price ranges. Consider your risk appetite, and invest accordingly. DYOR always!