Options Trading Essentials Series Part 3
In previous posts, we introduced the basics of options trading, explored pricing mechanics, and highlighted Stryke’s core features. Now, let’s dive into advanced strategies. Whether you’re a trader looking to maximise opportunities or a liquidity provider (LP) aiming to optimise returns, this post will equip you with actionable insights.
Mastering Expiration Strategies
Choosing the right expiration time is crucial to successful options trading. On Stryke, you can select from various expiration periods, ranging from short-term (1 hour) to longer-term (up to 1 week). Here’s how to decide:
Short-Term Expirations
- Ideal For: Capturing quick market moves or taking advantage of short-term volatility.
- Benefits: Lower premiums due to reduced time value.
- Consideration: Requires precise market timing; there’s a higher risk of losing the premium if the underlying asset doesn’t move in your favor before expiry. Even if your longer-term directional bias is correct, short-term options can expire worthless if the move takes too long to materialise.
- Example: A trader anticipates ETH will spike within the next two hours due to an imminent announcement. They buy a short-term call option to capitalise on the expected volatility.
Long-Term Expirations
- Ideal For: Hedging risks or capturing broader market trends.
- Benefits: More time for favourable price movements, reducing the pressure to time short-term moves perfectly.
- Consideration: Higher premiums due to extended time value; susceptible to time decay as expiration approaches. The cost may seem low relative to the underlying if volatility is moderate, but always confirm current premiums on the options chain.
- Example: A trader hedges their portfolio against a potential BTC price drop by buying a put option with a 1-week expiration. (Note: The exact premium cost will depend on current market conditions.)
Rethinking Implied Volatility (IV)
Implied Volatility (IV) is a critical factor in options pricing. It reflects the market’s forecast of future volatility. Traders and LPs should consider both the level of IV and whether it’s under- or over-priced relative to their expectations.
High IV
Opportunities: At first glance, high IV suggests the market expects big moves. Buying options in a high IV environment can yield large payoffs if the move is substantial.
Risks: However, high IV means more expensive premiums. Even if the market moves in your predicted direction, the hefty initial cost may erode your profits, potentially resulting in a loss. In such environments, it might be more advantageous for experienced traders (or LPs acting like option sellers) to consider providing liquidity—effectively “selling” these rich premiums.
- Example: Ahead of a major ETH upgrade, IV is high. Instead of buying a call outright, a trader might consider spreading the position or selling options (via providing liquidity) to take advantage of elevated premiums, with the understanding that a bigger-than-expected move can still cause losses.
Low IV
Opportunities: Options are cheaper, making it a good time to buy options if you anticipate volatility to increase later. Straddle or strangle strategies are more cost-effective in low IV environments, potentially paying off if volatility expands.
- Example: In a calm market phase, a trader buys a put option to hedge their portfolio against an unexpected downturn. The premium is modest, and if volatility spikes unexpectedly, the relative value of the put can increase.
Pro Tip on Volatility: Sometimes it’s advantageous to buy options when you expect implied volatility (IV) to increase, as this can make undervalued options more profitable. Conversely, selling options or providing liquidity when IV is already elevated might allow you to collect rich premiums—though this comes with its own set of risks.
Making Exercise Decisions
On CLAMM, options are automatically exercised 5 minutes before expiration if they are in-the-money (ITM) and the Auto-Exercise Feature has been manually enabled within the platform UI while opening the position. This ensures you don’t miss out on potential profits, though it’s important to note that this feature incurs a 1% fee on the PNL.
Auto-Exercise
How It Works: ITM options are settled automatically at expiration, delivering final PnL without manual intervention.
- Example: A trader purchases an ITM call option for WETH and cannot monitor the market closely. Auto-exercise ensures they capture profits without taking further action.
Note: Options that are out-of-the-money (OTM) at expiration expire worthless, with the premium paid as the maximum loss.
Optimising for Liquidity Providers
Providing liquidity on Stryke comes with unique opportunities and risks. While you can’t completely avoid impermanent loss, you can adapt your strategies based on market conditions and expected volatility.
Earning Premiums
Mechanism: By providing liquidity within a certain price range, LPs effectively earn premiums when traders interact with their liquidity. These premiums supplement standard trading fees.
- Example: An LP supplies liquidity in the $1,500–$1,800 ETH range. When a trader buys an option at $1,700, the LP collects a premium. If volatility is high, the LP earns a larger premium but also takes on more risk.
Risk Management
Adjusting Ranges: Rebalance and adapt your liquidity ranges based on your volatility expectations. A wider range may reduce the frequency of having to rebalance and mitigate some impermanent loss during highly volatile periods.
Hedging: Use Stryke’s analytics to gauge potential risks. Adjust your liquidity positions to account for expected big moves, possibly holding a wider range if you foresee significant volatility.
Practical Scenario Walkthrough
Scenario: Trader X holds 1 WBTC, currently priced at approximately $98,631.98, and anticipates a short-term market downturn. They turn to Stryke’s WBTC/USDC options chain to hedge their holdings.
Action Taken:
- Trader X buys a 1-week put option with a strike price of $98,206.30. For illustration, let’s assume the premium is around $1,771.00 (this is a hypothetical figure and actual premiums depend on IV, market conditions, and time to expiry). While this cost is not negligible, it represents roughly 1.8% of the WBTC’s value and could provide meaningful downside protection.
Outcome:
- If WBTC’s price drops: The put option gains intrinsic value, compensating for a portion of the losses in the underlying position.
- If the price remains stable or rises: Trader X loses only the paid premium, treating it as the cost of insurance against a potential drop.
Combination Strategies
- Spread Strategy
- X₁: The higher strike price where the put option is bought. This marks the level where downside protection begins.
- X₂: The lower strike price where liquidity is provided (effectively selling a put). This helps reduce the net cost of the strategy by collecting a premium.
- Maximum Profit: Achieved when the asset price settles at or below X₂. At this point, both puts are exercised, and the profit equals the difference between strike prices (X₁ - X₂) minus the premium paid.
- Maximum Loss: Limited to the net premium paid if the asset price remains above X₁, as both options expire worthless.
- Buy a put option near the current price: For example, at a strike near $98,206.30. Assume a premium of around $1,771.00, subject to real-time market conditions.
- Provide Liquidity at a Lower Strike: Instead of directly “selling” a put, Trader X provides liquidity at a lower strike (e.g., $98,010.09). By doing so, if another trader decides to purchase an option at that strike, Trader X effectively collects a premium—though they cannot control the exact timing or guarantee that a trade will occur at that specific level.
- The premium earned by providing liquidity at the lower strike (if and when it occurs) offsets some of the initial premium cost.
- Outcome: Profitable if WBTC’s price drops modestly (below the bought strike) but not too far. Losses remain capped if the price falls significantly. However, it’s important to note that providing liquidity does not ensure immediate offset of costs—it’s contingent on another trader taking the opposite side of the trade.
- Straddle Strategy
- K represents the strike price at which both the call and put options are purchased.
- V is the total cost (premium) paid for the two options combined.
- Buy a call option at a strike near the current price (e.g., $98,631.98).
- Buy a put option at a nearby strike (e.g., $98,206.30).
- The combined premium might be several thousand dollars depending on strikes and IV. In a low-volatility environment, these premiums will be smaller, making the strategy cheaper to enter.
- If WBTC makes a large move in either direction, one of the options can gain significant intrinsic value, potentially exceeding the total cost of the straddle.
- If WBTC’s price remains flat, the maximum loss is limited to the premiums paid.
- Entering when IV is low increases the likelihood that a subsequent rise in volatility (or a big price move) makes the strategy profitable.
The payoff diagram for a a put spread illustrates this strategy:
The payoff diagram highlights key variables:
The strategy becomes profitable when the price of WBTC falls below X₁, with optimal gains occurring at or below X₂. By combining a bought and sold put, the strategy lowers the overall cost of protection while capping both risk and reward.
Objective: Reduce the net cost of protection while limiting downside risk.
Example Action:
Net Effect:
Objective: Profit from significant volatility in either direction. This strategy is particularly appealing when IV is relatively low, as the initial combined premium cost is reduced.
The payoff diagram for a long straddle illustrates this strategy:
The payoff diagram highlights key variables:
The strategy becomes profitable if the asset price moves significantly away from K—either above (K+V) or below (K-V)—covering the premium cost V and generating net gains.
Example Action:
Total Cost:
Outcome:
Closing Practical Tips
For Traders:
- Monitor open interest and volume on the options chain to gauge market sentiment and liquidity.
- Use the profit/loss calculator to estimate outcomes before trading.
- Consider buying options when IV is low and you anticipate a volatility spike, or selling (via liquidity provision) when IV is high to collect richer premiums—while staying aware of the risk of large market moves.
For LPs:
- Regularly review utilisation rates to ensure liquidity ranges remain effective.
- Diversify and adjust your ranges wider if you expect higher volatility to reduce the frequency of rebalancing and partially mitigate impermanent loss.
- Align your liquidity provision with your market expectations and risk tolerance.
Final Thoughts
Stryke empowers traders and LPs with a comprehensive toolkit for navigating the on-chain options market. By refining your approach to expiration selections, understanding IV dynamics, and employing advanced combination strategies, you can better position yourself for opportunity—whether you anticipate big moves or want to hedge against downside risks.
Happy trading!
About Stryke
Stryke is a decentralised options protocol that focuses on maximising liquidity and enhancing gains for option buyers while minimising losses for option writers—all in a passive approach. Stryke employs option pools that enable anyone to effortlessly earn yield. The protocol provides value to both option sellers and buyers by ensuring equitable and optimised prices for options at various strike prices and expiries, achieved through our proprietary, cutting-edge option pricing model designed to mirror volatility smiles.
📱 Stay Connected
Stay informed by following our official social media accounts and visiting our website to keep up with all things Stryke.
🚨 IMPORTANT
Be careful of fake Telegram groups, Discord servers and Twitter accounts trying to impersonate Stryke.