This article will briefly touch on some basics about selling “Volatility”. I am hoping everyone knows what volatility is and what the lack of volatility is. To quickly touch on what volatility is, it’s a measure of how drastically the price of an asset swings from its mean. Volatility is one of the main components of options, and there are two different types of volatility, Historical and Implied. Historical Vol focuses on the price fluctuations over a previous predetermined time, while Implied Vol also known as IV gives you a way to determine potential future volatility. We can get into more details later on.
Now to play options based on Vol you need to know your market conditions and asset. Are you playing with a volatile ticker? Are you currently seeing it crab or range? Hopping into options without understanding the risk can damage your portfolio and trading mentality, so think before you jump in. Typically when I think Vol I’m thinking of tickers that get massive price spikes or significant moves that come in cycles. We all know that there are tickers that produce volatility with 20%+ moves and we know tickers that haven’t done anything outside of 5% moves for weeks.
In the last article, we discussed Calls and Puts, the simplest form of options where you benefit from directional price movements or directional volatility depending on if you are betting purely up or down. These have unlimited potential in return and hold their own risk for that potential. Now other options strategies cap your potential in return but offer you a different way to play the asset. Let's look into Covered Calls and Put Selling, also I wont discuss “naked” versions in this article which means you don’t own the underlying asset , Naked call-writing and naked put selling is much riskier and will be discussed as a add-on to this article.
Covered Calls
Playing Covered Calls is essentially you selling calls on an asset you own. So how in the last article 1 options contract = 100 shares, you have 100 shares of the underlying asset and are selling 1 call per 100 shares. This is a type of hedge strategy which allows you to generate income by collecting Premiums. When using a Covered Call strategy you want is the asset price higher than strike and breakeven point, when the price is stuck in a range with short pumps you can collect an repeat. Your capped on the upside in gains and will miss the stock gains if it pumps too much. Broadly flat is the best case while still collecting premiums.
Example:
Michael Maylor noticed Luna is trading at $20 and a call options strike of $20 is expiring in 3 months which would cost $4 per contract.
Premium = $4 x 100, as you should know 1 contract is equivalent to 100 shares so it comes out to $400.
To make this work, what he would need to do is buy 100 shares of Luna so he can sell 1 single call to earn those 400 dollars.
When it comes to covered calls the max you can make is the options premium but you can lose more than the premium if the asset falls more than expected. The issue with Covered Calls is that you typically need more capital to get a covered call going as you need the underlying asset to sell calls on (100shares = 1 options contract). You trade off the potential that the asset might moon but get to hedge your risk and make passive income by setting up a Covered Call on the asset that might not move as much or have no volatility within a set period.
TLDR to take
Premium is the cost of the option contract and there are various factors like time of expiration, a ITM strike or a OTM strike. If you have a further out option expiration it will typically always cost more vs a shorter term one.
Put Selling
Put Selling is done when you speculate the asset price will remain flat or have no volatility making the option worth nothing. It’s the opposite of when you buy a put and profit from the asset price decline. In this case, you will profit when the asset fails to move or when the price closes higher, in both cases resulting in worthless options. When you sell a put, you are given a premium ahead of time for doing this. When you sell a put you are capped on your gains with the premium you received for selling in the first place. If you sell puts appropriately it’s a way to generate cash, especially if you don’t mind the asset dipping if things go wrong and you have to purchase them. You do take a considerable risk if it moves unfavorably.
Example:
Harther Aayes has noticed that altcoins haven’t been moving much outside of a minimal price range with a tiny burst of volatility.
He wants to sell 1 put on KSM which is at $40 with a strike of $40 costing $4.00 which would net him a premium of $400 .
Mr. Aayes profits if KSM never falls below $40 or closes higher. He gets to keep the premium of 400 and isn’t required to exercise his contracts and buy them.
Essentially when it comes to put selling, you do take the risk that if the asset drops significantly you are still going to be obligated to buy the shares at the original strike price. This sometimes works if you are okay with the fact you might end up bag-holding but want to collect a short-term income for having said asset or DCA-ing at a higher point.
There are so many trading strategies in legacy that are available for advanced traders or for people looking for more in-depth ways to hedge. Imagine when we have access to suitable options in crypto, and we can sell puts on doge at support or continuously purchase liquid covered calls on your favorite altcoin. Look forward to my next article two articles “What is a Decentralized Options Vault” and “Discussing Straddles & Strangles” . I hope this was helpful and stay subbed for future articles!
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This article was sponsored by Ribbon Finance, as I’m currently working with them on their new upcoming options exchange Aevo.