A strategic approach in options trading where the maximum potential financial loss a seller faces is precisely quantified and limited from the outset of the trade. This contrasts with naked option selling, which carries unlimited risk. In crypto options, this technique is employed to control exposure when taking a short volatility or directional stance.
Mechanism
This strategy typically involves selling one option while simultaneously purchasing another option of the same class (either calls or puts) on the same underlying crypto asset, but with a different strike price or expiration. This combination establishes a price range where the seller’s profit is capped and, crucially, their potential loss is constrained by the difference in strike prices minus the net premium received or paid.
Methodology
Implementing defined-risk option selling involves careful selection of strike prices and expiration dates to construct specific option spreads, such as credit spreads or debit spreads. Risk parameters are analyzed through scenarios and sensitivity analysis, allowing traders to align their exposure with their risk tolerance and market outlook for the underlying cryptocurrency. This systematic approach supports capital efficiency and controlled risk management within institutional crypto derivatives trading.
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