Crypto options can be used to hedge your perpetual contract positions, allowing you to lock in a fixed profit should the market rise or fall, while not limiting your upside gains.
Why hedge my PNL?
You want a good night’s sleep. You want to remove the risk of losing your PnL gains should any sudden price spikes/drops for a respective asset occur.
Example Scenario
Using a fictional market scenario, let’s look at an example of how this strategy can be done.
- You bought one BTC (Bitcoin) via a long perpetual contract at $40,000.
- The current BTC price is $47,000.
- This means you have an open profit of $7,000 on your long position.
- You remain bullish on BTC and have no desire to close the position yet
- However, you want to remove the risk of losing your profit due to any sudden price drop in BTC – say, below $45,000.
How to use Options to Hedge PNL
Given the above scenario, you can purchase a Put Option for one BTC with a $45,000 Strike Price. This will cost a $1,000 Premium.
What happens if the price of BTC drops?
Should the price of BTC drop (e.g. below $45,000), the Put Option protects you from the market action.
What happens if the price of BTC rises?
Should the price of BTC continue rising (e.g. above $47,000), your long perpetual position will continue giving you profit.
The only expense incurred in this scenario is the $1,000 premium paid for your downside protection.
What happens at expiry?
Once the expiry date hits (e.g. 28/5/2024), your option position will be automatically exercised if it’s profitable. You’ll receive your payout if the spot market price of BTC is below $45,000.
So if the BTC price is at $38,000 on the expiry date, then the payout from your $45,000 strike price put option would be $45,000-$38,000= $7,000.
Remember, once your option expires, you are no longer protected against price movements. However, let’s look at the position as a whole:
- If settlement is below $45,000, you are now effectively long one BTC via your perpetual contract position at (Settlement Price – $45,000 + $1,000) + $40,000 = Settlement Price – $4,000.
- If settlement is at $45,000 or above, you are now effectively long one BTC via your perpetual contract position at $41,000.
On BitMEX Options, you’ll receive your payout in USDC so you don’t have to go through any further asset conversions to cash out.