Top 2 Options Strategy for a Market Downturn

What to do in a Market Downturn

During a market downturn, investors may face losses as the value of their holdings. However, downturns also present opportunities for experienced investors to hedge risks or even profit from falling asset prices through various strategies, including options trading.

What is a Market Downturn?

Market Downturn

A market downturn refers to a sustained period where the prices of cryptos fall across the broader market or within specific sectors. This decline in prices can be caused by various factors, such as economic slowdowns, cyber attacks, rising interest rates, political tensions, or shifts in market sentiment.

Market downturns can be classified into different types based on their severity and duration:

  1. Corrections: A market correction occurs when an asset or market declines around 10% from its recent peak. Corrections are often seen as a natural part of market cycles and can provide buying opportunities for long-term investors.

  2. Bear Markets: A bear market however tends to identify a much longer lasting and serious downturn, typically defined by a 20% or greater drop in the value of major crypto currencies like Bitcoin or Ethereum. Bear markets often accompany recessions and periods of economic contraction.

  3. Crashes: A market crash is a sharp, sudden drop in asset prices, often within a single trading session or over a few days. Crashes are driven by panic selling and are typically triggered by unexpected events like financial crises, major cyber attacks, or political shocks.

 

How Can We Protect Our Portfolio in a Market Downturn?

When the market takes a bearish turn, investors often look for ways to protect their portfolios or capitalize on declining prices. Options trading provides various strategies that can benefit from such market conditions. Two of the most popular and effective options strategies for a market downturn are the Short Call and Long Put. Let’s explore these strategies, how they work, and why they are suitable for bearish markets.

1. Short Call Strategy

Definition: The Short Call is an options strategy where the investor sells a call option without owning the underlying asset. In simpler terms, it involves selling the right (but not the obligation) to another investor to buy crypto at a specified price (the strike price) before the option’s expiration date. The goal here is to profit from the premium received when the option is sold.

How It Works:

  • When you sell a call option, you receive a premium from the buyer.

  • If the market price of the underlying asset stays below the strike price until expiration, the option will not be exercised. You get to keep the entire premium.

  • However, if the market price rises above the strike price, the buyer may exercise the option, and you will be obligated to sell the asset at the strike price, potentially incurring significant losses.

Why Use It:

  • In a bearish market, asset prices are expected to decline or stay stagnant. In such conditions, the likelihood of the option being exercised is low, meaning you can safely collect the premium as profit.

  • The maximum profit is limited to the premium received, while potential losses can be substantial if the market unexpectedly turns bullish, making it a risky strategy.

When to Use:

The Short Call strategy is suitable when you are confident the asset’s price won’t be able to rise higher in a specific amount of time, it could only fall or remain flat (sideways). But most investors only use this strategy when they calculate that the chances of price going sideways is the highest. It is ideal for advanced investors who have the ability to analyze market trends precisely as this is a high risk strategy which contains limited return but unlimited risk.

2. Long Put Strategy