Bybit Options Lesson: Understanding Put Options

Key Takeaways:

• A put option is an agreement that allows buyers to predict that the value of an asset will drop, with an agreed-upon amount for a particular price and date to earn the premium.

• With a put option, a buyer can earn the premium based on the buy/sell call contract when the market price of the underlying asset declines in price.

Crypto put options and call options are opposites. A put option primarily benefits from a decline in market price. However, since a portion of a crypto put option’s value is tied to a fall in the price of the underlying currency, the value of a put option increases with a decrease in the underlying asset's price. A put option begins to lose value with a rise in the price of the asset to which it’s tied. 

When buying a put option, a buyer is predicting that the asset's value will drop over a specified time frame before the expiration date. Conversely, when selling a put option, the seller speculates that the asset's value will rise or remain unchanged during the valid period of the contract, or before the option expires. If the market price moves in favor of the option holder, they can decide to exercise their put by selling the underlying asset at the strike (or set) price. 

Example of a Crypto Put Option

Let’s say that Sandra, an investor, decides to buy a Bitcoin put option as a form of insurance over her position in Bitcoin. After a while, she speculates that a bear market is near, and she isn’t ready to forfeit more than 10% of her long position in Bitcoin. Furthermore, let’s assume that Bitcoin is currently trading at $60,000 per coin, and Sandra purchases a put option that will give her the right to sell it at $54,000 within the next two years.

If, within 6 months, a 20% loss is recorded, Sandra will have recovered simply by being able to sell at $54,000, rather than the current market price of $48,000 — a loss of only 10%. Even if the market crashes to $0, Sandra will only record a loss of 10%.

Conversely, if the market doesn’t drop within this time frame, Sandra can decide to let the put expire. If she does so, she’ll only lose the premium fee.

Buying and Selling Puts: Strategies and Examples

Long Put

This is a popular strategy used by traders. Here, the trader buys a “going long” put option in the hope that the market price will fall below the strike price at expiration. The benefit of this strategy is that in the event of a drastic price reduction, the trader can get back many times their initial investment.

Short Put

This is simply the opposite of a long put. Here, the trader sells a “going short” put in the hope that the asset’s price will rise above the strike price at the expiration point. The seller of the put earns a premium in exchange for selling the put. 

This premium is the highest reward that can be obtained for trading a short put. If the asset’s price falls below the strike price, the trader is obligated to buy it back at the strike price.

Married Put

This is simply an upgrade of the long put. In this case, the trader buys both the underlying asset and a put option. This is a hedging technique in which the trader expects the asset’s price to soar, but still wants insurance in case its price declines. If it actually does, the long put covers the loss incurred.

Bull Put Spread

This strategy is very popular in options trading. The bull put spread is typically used when the call trader or call writer speculates on an increase in the future price of an underlying asset.

The key to using this strategy is to sell higher and buy lower. Simply put, you sell a put option with a higher strike price, and then buy another option with a lower strike. However, both options must have the same expiration date. 

Although the risks involved here are minimal, they do still exist. If, at expiration, the asset’s price moves below the strike price, a loss will be recorded, as the two put options will be ITM.

Bear Put Spread

The bear put spread is applied when an investor predicts a decline in the price of an asset. This strategy aims to reduce cost and risks, while also ensuring that the investor makes as much profit as possible.

To use this strategy, the investor first purchases a buy put option, after which they purchase a sell put option with a lesser strike price. For this to work, both options must be tied to the same underlying asset and have the same expiration date.

Summary

A put option is a great hedging tool, and many traders swear by it. But no financial instrument is risk-free. In order to limit their losses, traders should do their due diligence to see if the product aligns with their risk appetite. 

Learn more:

• Put Options: Effectively Manage Price Risk With This Tool

• Bybit Options: Advantages to Hedge Your Positions & Maximize Profits