Gu Yanxi: Bitcoin miners need to consider using options to hedge risks

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Miners can use the option Covered Call strategy to obtain stable income and prevent market downside risks.

Original title: “Bitcoin miners need to consider how to use options”
Written by: Gu Yanxi, founder of the American Liyan Consulting Company, a researcher and practitioner in the blockchain and encrypted digital asset industry

Bitcoin has developed to this day, and its mode of operation is becoming more and more like a commodity such as petroleum soybeans. On the one hand, it has an actual production process, and the miners are using their own equipment to produce Bitcoin through mining. On the other hand, in the trading market, there are a large number of bitcoin spot and derivative transactions in the market. Since these trading methods are more convenient than mainstream commodity trading, the corresponding trading volume is also very large. Unlike mainstream commodity transactions, Bitcoin’s spot and derivatives transactions are basically carried out on a 7*24 basis. In addition, due to the characteristics of Bitcoin itself, the price of Bitcoin has changed greatly. For miners, it is very important to guard against market risks and avoid losses. In this respect, Bitcoin miners have the same concerns as producers of commodities such as soybean oil.

In dealing with the market risk of Bitcoin, the most commonly used financial instrument is futures. Miners can use futures to ensure that they sell the bitcoin they can produce at a suitable price. As a hedging tool, futures has its advantages. These advantages include the characteristics of leverage, continuous changes in the underlying price, the huge number of transactions that can be supported, and so on. But futures also have their limitations, including relatively single functions and very high unilateral risks. Futures are two-way collection of margin. That is to say, for both bulls and bears, if the market trend is opposite to the trader’s position, then he will increase the margin. During periods of significant market turbulence, there is even a risk of liquidation.

Compared with futures, options are more suitable for individual Bitcoin miners to be used as trading tools to hedge market risks and obtain stable returns. Options include call options and put options. The lower limit risk of trading parties who use options to do long is only the premium paid for this. Only the short side has huge risks. And you can use options to develop various trading strategies to achieve arbitrage or value preservation. For Bitcoin miners, if they understand the characteristics of Bitcoin options provided by the market, it is possible to find a trading tool that is more suitable for them. They can use their Bitcoin to earn stable income or prevent downside risks.

For example, miners can use the option Covered Call strategy to obtain stable income. Figure 2 lists the bitcoin options transaction quotations of a derivatives exchange in the United States. We can see that in March 2021, the quoted price of the option market with a strike price of $50,000 is $210. If the miner holds a bitcoin, he can sell the call option at this strike price. He can therefore receive a royalty of $210. If the Bitcoin spot price does not reach $50,000 before March 26, 2021. This miner can keep a royalty of $210. If the spot price of Bitcoin at that time exceeds $50,000, and the trader who bought this option chooses to execute, then the Bitcoin miner can also sell his Bitcoin at a price of $50,000. This can also achieve very good profits. If the miner does not use options as a trading tool, but directly operates in the spot trading market, then he can only get the profit of spot trading, and lose the opportunity to earn option premiums.

Figure 1. Covered Call trading strategy

Gu Yanxi: Bitcoin miners need to consider using options to hedge risksFigure 2. Quotes of call options on options exchanges

For Bitcoin miners, another important role of options is to prevent downside risks in the market. To this end, you can use Protective Put’s trading strategy. Miners buy put options at a low price in a market. If the market spot price falls to this price, then the miner can at least sell his bitcoin at this price to avoid greater losses. If the price of Bitcoin goes up, then his Bitcoin holdings will increase in value. The overall bitcoin spot and put options he holds are still able to achieve very good returns. For example, as shown in Figure 4, on March 26, 2021, the price of a put option with an exercise price of $15,000 is $1,399. In order for a miner to ensure that a bitcoin he holds can be sold at this price, he can pay $1,399 to purchase this power. In case the Bitcoin market price drops below $15,000, he can sell his Bitcoin at this price.

Gu Yanxi: Bitcoin miners need to consider using options to hedge risksFigure 3, Protective Put trading strategy

Gu Yanxi: Bitcoin miners need to consider using options to hedge risksFigure 4. Quotation of put options for option trading

The feature of options is that users with small capital can also participate in the transaction. Therefore, the trading volume of stock options is very active. In addition, because of its flexibility and the ability to configure multiple types of trading strategies, it is also very popular with traders who are good at quantitative trading. But for the average miner, understanding the basic properties of options and carrying out the correct trading strategy can use it to achieve their own goals.

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