Bitcoin Options - Part III
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When I started this series the idea was to track the launch of a new wealth engine — trading bitcoin options.
While I am still open to this idea, the options chain is still maturing for BTC and there are other chains (MSTR for example) with much more liquidity and the volatility you need to make an income generating options strategy operationally successful.
The plan is still to sweep the profits from this account on a regular basis and use them to buy bitcoin. I’m just going to broaden my horizons and get familiar with several options chains.
Last time out in Part II we discussed the Options Wheel strategy. Once we built our wheel we layered in something called the Ladder, and discussed a few other strategies too.
Today we’re going to dig deeper into 6 income generating strategies.
The Strategy Playbook
Strategy 1: The Options Wheel
A continuous cycle of generating income with options, aiming to profit primarily from time decay (theta) while also potentially benefiting from stock price movements. It involves selling cash-secured puts on stocks you'd be willing to own and, if assigned, selling covered calls on those owned shares.
Mechanism:
Sell Cash-Secured Puts: Sell out-of-the-money or slightly in-the-money put options on a stock you believe will stay above the strike price. Collect the premium.
If Assigned: If the stock price falls below the strike price at expiration, you are obligated to buy the shares at the strike price. You now own the stock.
Sell Covered Calls: Once you own the stock, sell out-of-the-money or at-the-money call options against your shares. Collect the premium.
Repeat: If the call option expires worthless, you keep the premium and can continue selling calls. If the call option is assigned, you sell your shares at the strike price (potentially with a profit) and can start the cycle again by selling cash-secured puts on a different stock or the same one.
Obviously we make money from the premium collected from selling puts and calls. This is known as theta decay.
There’s so such thing as free money, and this strategy is no different. This strategy requires tying up capital for cash-secured puts, limited upside potential on owned shares (capped by the call strike price) and of course potential for losses if the stock price declines significantly below your put strike.
Risk Management:
Stock Selection: Focus on fundamentally sound companies you'd be comfortable holding long-term.
Cash Reserves: Ensure you have sufficient cash to cover the purchase of shares if put options are assigned.
Position Sizing: Manage the number of contracts based on your risk tolerance and available capital.
Rolling Options: Consider rolling options to a later expiration date if the stock price moves against you to avoid assignment or maximize premium.
Ideal Market Conditions: Range-bound or slightly bullish market conditions.
Strategy 2: Covered Call Writing
Generating income by selling call options on stocks you already own. This strategy leverages existing long positions to generate a consistent stream of income from time decay.
Mechanism:
Own Shares: Hold a long position in a stock (at least 100 shares per call option contract).
Sell Call Options: Sell out-of-the-money or at-the-money call options against your owned shares. Collect the premium.
Expiration:
Option Expires Worthless: You keep the premium, and your shares remain unassigned. You can then sell another call option.
Option is Assigned: You are obligated to sell your shares at the strike price. You realize the premium income and potentially a capital gain if the strike price is above your purchase price.
This is another theta decay strategy. It is loved by many in the options community due to the relatively low risk compared to other option strategies (as you already own the stock) and the opportunity it provides for consistent income.
Again, there are risks: limited upside potential (capped by the call strike price), potential for missing out on significant stock price appreciation, opportunity cost if the stock price falls.
Risk Management:
Stock Selection: Focus on stocks you are comfortable owning long-term, even if called away.
Strike Price Selection: Balance income generation (closer to the money) with the desire to retain the shares (further out of the money).
Rolling Options: Consider rolling the call option to a later expiration date if the stock price approaches the strike price and you don't want to sell your shares.
Ideal Market Conditions: Neutral or slightly bearish market conditions where the stock price remains stable or doesn't rise significantly above the call strike price.