Selling Options on Crypto for Passive Income
Selling call options or put options is a great way to generate income-- in many ways, it's quite similar to selling insurance. Keep reading to find out more on how to generate income and hedge against risks.
Selling call options or selling put options is a popular strategy to generate passive income and boost returns on crypto. This strategy is very similar to selling insurance. You collect a premium by selling options (call or put). A typical call/put selling (writing) strategy involves finding a price you believe the underlying will not reach by the expiration date. The price (aka strike price) you choose should be an OTM (out-of-the-money) that has a low probability of being reached. See the illustration below for an example of selling a call or put on Ethereum:
Sell Call Option on Ethereum Example:
Sell Put Option on Ethereum Example:
The benefit to doing this is that you can pick up additional income from your position (Ethereum for example) you already own. The obvious question you might ask is, “This sounds great, but what’s the catch?” Just like an insurance company, you’ll have to pay out a claim every so often-- in this case, you’ll have to pay out if the option you sold gets exercised. This means that if the price of the asset is above the strike you chose at expiration, or what’s called in the money (ITM),you may end up with less money than you started with.
Having a viewpoint and/or expectation of the market volatility or direction is the first step in deciding on a strategy. There is no right or wrong way to come to a conclusion, but ultimately, you want to avoid the price of the underlying asset going ITM by more than the premium you collected by the time expiration rolls around.
Let’s say ETH is currently at $3,293.72. You decide to sell a put option for $29.56 with a 10-day expiration period with a strike price of $2,560. In this scenario, you want the price of ETH to be above $2560. To ensure a profit, you want to make sure it is at least $2530.44 (Strike - Premium collected). There are 3 outcomes that you should be aware of when taking on this position:
Understanding Naked vs. Covered Short Positions
When you sell options (put or call), there may be some terminology that might be thrown at you along the lines of a “cover call” or “naked put”. The term naked and covered is derived from the collateral that is required. When a position is fully collateralized, the position can not lose more money than the collateral provided. For example, if you want to sell 1 put option at $2560, you would need to post $2560 USD as collateral to be fully collateralized. If you are selling one call option, you will need to post 1 ETH as collateral to be fully collateralized.
Any position that is not fully collateralized is naked. This means that the max potential loss exceeds the amount of money that is posted as collateral. This brings on the risk of liquidation of your option position.
It is common practice to use percentages that are annualized when looking at potential returns of strategies. While there is no guarantee to get that rate of return for the duration of the year, it can be benchmarked against other yield producing products to easily compare and contrast risk/reward profiles across multiple strategies.
For example, if we use the example above and make the assumption that the put option we sold expired OTM (worthless), then we can derive an annualized yield as follows:
Premium/Collateral * 365/DTE
For our example, the equation would be $29.56/$2670 * 365/10 = 40% annualized yield! As you have read above, there is no such thing as a free lunch. This return is not guaranteed, and it is very likely that you’ll encounter a loss at some point in time if you continue to sell OTM options (which is not implied with the annualized return).
In conclusion, selling options can be a great way to generate additional returns on crypto while also diversifying your portfolio. Understanding the risks and rewards are the first step in making successful decisions. Your assets, your future, your terms-- that’s Rolla's promise to you.