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DeFi Option Trading: The Top 10 Strategies

There are many options strategies in decentralised finance that both limit risk and maximise return. With a little effort, traders can learn how to take advantage of the flexibility and power that stock options can provide.

Jan 12, 2022

There are many options strategies in decentralised finance that both limit risk and maximise return. With a little effort, traders can learn how to take advantage of the flexibility and power that stock options can provide.

Top 10 Options Trading Strategies

Here are 10 options strategies that every DeFi investor should know.

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1. Covered Call

This is a very popular strategy and it is almost always preferable to naked stock because it allows traders to profit when the stock does not move at all, and it also reduces their losses to a maximum if the stock price falls. The trade-off is that you must be willing to sell your shares at a set price–the short strike price.

Covered call

For example, suppose an investor is using a call option on a stock that represents 100 shares of stock per call option. For every 100 shares of stock that the investor buys, one call option would simultaneously be sold against it. This strategy is referred to as a covered call because, in the event that a stock price increases rapidly, the investor’s short call is covered by the long stock position.

Covered call option

2. Protective Put (Married Put)

In this strategy, an investor purchases shares of stock and simultaneously purchases put options for an equivalent number of associated shares.

An investor may choose to use this strategy as a way of protecting their downside risk when holding a stock. This strategy functions similarly to an insurance policy; it establishes a price floor in the event that the stock’s price falls sharply.

Protective Put (Married Put)
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3. Protective Collar

A protective collar strategy is performed by simultaneously purchasing an out-of-the-money put option and writing an out-of-the-money call option. The underlying asset and the expiration date must be the same. This strategy is often used by investors after a long position in a stock has experienced substantial gains. This allows investors to have downside protection as the long put helps lock in the potential sale price. However, the trade-off is that they may be obligated to sell shares at a higher price, thereby relinquishing the possibility for further profits.

protective collar
When to use protective collar

4. Long Call Spread

This strategy is a type of vertical spread strategy. A vertical spread involves the simultaneous buying and selling of options of the same type (puts or calls), with the same expiration date but a different strike price.

In a long call spread strategy, an investor simultaneously buys calls at a specific strike price while also selling the same number of calls at a higher strike price. Both call options will have the same expiration date and underlying asset. This type of vertical spread strategy is often used when an investor is bullish on the underlying asset and expects a moderate rise in the price of the asset. Using this strategy, the investor is able to limit their upside on the trade while also reducing the net premium spent (compared to buying a naked call option outright).

long call spread
When to use long call spread

5. Long Put Spread

The long put spread strategy is another form of vertical spread. In this strategy, the investor simultaneously purchases put options at a specific strike price and also sells the same number of puts at a lower strike price. Both options are purchased for the same underlying asset and have the same expiration date. This strategy is used when the trader has a bearish sentiment about the underlying asset and expects the asset’s price to decline. The strategy offers both limited losses and limited gains.

long put spread
when to use long put spread

6. Long Straddle

A long straddle options strategy occurs when an investor simultaneously purchases a call and a put option on the same underlying asset with the same strike price and expiration date. An investor will often use this strategy when they believe the price of the underlying asset will move significantly out of a specific range, but they are unsure of which direction the move will take. Theoretically, this strategy allows the investor to have the opportunity to make unlimited gains. At the same time, the maximum loss this investor can experience is limited to the cost of both options contracts combined.

long straddle
When to use long straddle

7. Long Strangle

In a long strangle options strategy, the investor purchases an out-of-the-money call option and an out-of-the-money put option simultaneously, on the same underlying asset with the same expiration date. An investor who uses this strategy believes the underlying asset’s price will experience a very large movement but is unsure of which direction the movement will go. Strangles will almost always be less expensive than straddles because the options purchased are out-of-the-money options.

long strangle
when to use long strangle

8. Long Call Butterfly Spread

A butterfly spread is an options strategy combining bull and bear spreads, with a fixed risk and a capped profit.

In a long butterfly spread using call options, an investor will combine both a bull spread strategy and a bear spread strategy. They will also use three different strike prices. All options are for the same underlying asset and expiration date.

Long Call Butterfly Spread
when to use Long Call Butterfly Spread

9. Iron Condor

In the iron condor strategy, the investor simultaneously holds a bull put spread and a bear call spread. The iron condor is constructed by selling one out-of-the-money put and buying one out-of-the-money put of a lower strike–a bull put spread–and selling one out-of-the-money call and buying one out-of-the-money call of a higher strike–a bear call spread. All options have the same expiration date and consist of the same underlying asset. Typically, the put and call sides have the same spread width. This trading strategy earns a net premium on the structure and is designed to take advantage of a stock experiencing low volatility. Many traders use this strategy for its perceived high probability of earning a small amount of premium.

iron condor
when to use iron condor

10. Iron Butterfly

In the iron butterfly strategy, an investor will sell an at-the-money put and buy an out-of-the-money put. At the same time, they will also sell an at-the-money call and buy an out-of-the-money call. All options have the same expiration date and are in the same underlying asset. Although this strategy is similar to a butterfly spread, it uses both calls and puts (as opposed to one or the other).

iron butterfly

Learn More

Test your new knowledge on option strategies and start trading. If you are looking for more insights on options, check out our Introduction to Options article for a 101 on the topic. In addition, our article on Greeks in Options describes this vital risk management tool for any trader.

References
1. https://www.desjardins.com/ca/co-opme/action-plans-tips/savings-investment/why-use-options/index.jsp
2. Pricing Option (Jun, 2019), Retrieved from: https://www.nasdaq.com/articles/pricing-options-2019-06-10

Tags

crypto

DeFi

investments

options

trading

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