A beginner's guide to multi-leg crypto option strategies

When you think of crypto options, you may be reminded of the YOLO all-in option plays that often flood social media feeds with their staggering amounts of gains and losses. While most traders will be focused on the potential leveraged gains that can be made with crypto options, they often forget that it only takes a couple of bad, risky trades for all the gains to be wiped over. That's where mitigation tools like multi-leg crypto option strategies come in.

As a tool that's well-known in the arsenal of TradFi traders, multi-leg option strategies take risk mitigation to the next level by limiting losses and increasing the chances of consistent, long-term gains. In this guide, we'll walk you through the basics of multi-leg crypto options strategies, their benefits, and how you can get started trading them.

TL;DR

• Multi-leg crypto options are complex strategies that involve combining multiple option contracts to manage risk and potentially increase gains.

• Multi-leg crypto options strategies are quickly becoming popular because they offer traders an advanced way to balance their risk-reward ratio.

• Key benefits of trading multi-leg options include risk mitigation, the ability to earn gains from volatility, and enhanced flexibility. Conversely, key risks include increased complexity, higher costs, and limited liquidity.

• Popular multi-leg option strategies for crypto traders include spreads, straddles, strangles, and iron condors.

• Best practices for getting started with trading multi-leg options are to start small, understand fees, use risk management tools, avoid emotional trading, and educate yourself.

What are multi-leg options?

Multi-leg options are a set of two or more option positions that are executed simultaneously to form a single strategic trade. These strategies involve buying and selling options contracts with different strike prices, expiration dates, or both. Multi-leg strategies are considered more complex than their single-leg counterparts, where you only trade one contract, such as a simple call or put option.

For crypto traders, multi-leg options present a powerful way to reduce risk, optimize gains, and tailor trading positions to market conditions. This is crucial in a market as unpredictable and volatile as crypto, where price swings are common.

Why multi-leg crypto option strategies are gaining popularity

In the unpredictable world of crypto trading, managing risk while seizing lucrative opportunities is a fine art. Multi-leg crypto options strategies offer traders an advanced tool to balance potential losses with gains. However, the key to success lies in understanding how to weigh the risks against the potential rewards effectively. Let’s explore how you can apply these strategies to protect your trading capital while capitalizing on market volatility.

Understanding the risk-reward trade-off with multi-leg crypto options

When trading crypto, understanding the balance between risk and reward is paramount. Put simply, risk refers to the potential downside or loss in a trade while reward represents the potential upside or gain.

As a trader, your goal is to identify strategies that offer a favorable risk-reward ratio, where the potential reward outweighs the risk. In a volatile crypto market, it can certainly be challenging to ensure a disciplined and balanced approach to successful trading. Often, you may find yourself wondering how to make sure that the risks you take with multi-leg crypto option strategies are calculated and not too reckless.

Key factors affecting risk-reward in multi-leg crypto options

Let’s break down the critical factors shaping the risk-reward profile of multi-leg crypto options strategies that you should keep in mind.

1. Option strategy complexity

The more intricate a strategy, the higher the potential for both risk and reward. While a single-leg option limits you to either a call or put, multi-leg option strategies involve layering multiple positions. This increases complexity but tends to open more doors for tailored outcomes based on your market outlook and how you want to be positioned.

2. Implied volatility

Understanding implied volatility (IV) can either make or break you when considering the risk-reward of multi-leg crypto option strategies. In short, IV is a metric that reflects the market's expected volatility of asset prices. In the case of crypto options, IV tends to be higher thanks to the inherent volatility of the crypto market. As such, certain multi-leg option strategies that involve long option positions may fall apart when IV is crushed post-catalyst. Conversely, this plunge in IV may work in favor of multi-leg option strategies with short option positions.

3. Option premiums

The cost of options tends to impact your overall risk-reward balance. For example, if you're buying a straddle or strangle, high option premiums can increase your initial upfront capital. This can make the multi-leg option strategy more expensive and risky because of the increased breakeven point.

4. Time decay

Time decay, or theta, refers to how an option's value diminishes as it nears expiration. In multi-leg options, where you're selling options and writing contracts, time decay can either work for or against you. It’s important to understand how each leg of your strategy will be impacted as the crypto option inches closer to expiration.

5. Hedging strategies

On top of the risk mitigation with long and short legs, multi-leg option strategies can also be used to hedge other existing spot and future positions. For example, a collar can be used to protect a long spot position from downside risk while limiting upside potential. The risk-reward of such hedging strategies ultimately depends on the specific components and market conditions.

Key benefits of trading multi-leg crypto option strategies

Multi-leg options offer several advantages over single-leg options, particularly in highly volatile crypto markets.

• Risk mitigation: Multi-leg strategies help to manage risk by balancing out gains and losses. Certain strategies even have defined risk profiles, allowing traders to control their maximum potential loss and exposure to specific coins and tokens.

• Benefits from volatility: Crypto's notorious price fluctuations can work in your favor when using strategies like straddles or iron condors that pride themselves on volatility.

• Enhanced flexibility: You can customize your trades based on your outlook, whether you expect sharp price movements or a more stable trend. This tailored form of adaptability makes such multi-leg options highly popular among traders trading on shorter timeframes.

Risks of trading multi-leg crypto option strategies

On the other hand, trading multi-leg crypto option strategies also poses the following risks that crypto traders should consider.

• Increased complexity: Multi-leg strategies can be more complex to understand and manage compared to single-leg options. Sometimes, this complexity can lead to mistakes in premium calculations or mishandled executions that can lead to significant losses.

• Higher transaction costs: While traders are welcome to add more legs to their crypto option strategy, buying multiple crypto options can increase the initial cost of the trade. Frequent adjustments or rebalancing can also incur higher transaction costs.

• Risks of limited liquidity: Crypto options may have limited liquidity, especially for less popular coins and tokens, or if you're opting for strategies with strike prices that are far from at-the-money (ATM). This can make it difficult to enter or exit positions at desired prices, potentially leading to slippage or unfavorable execution.

Common examples of multi-leg crypto option strategies

Spreads

Also known as verticals, spreads involve buying and selling options of the same type (either call or put), with the same expiration date but different strike prices. They’re ideal for traders who expect a moderate price movement and want to limit both potential gains and losses.

• Example: Suppose you expect Bitcoin to rise but want to limit your downside based on the amount of premium paid. You could execute a bull call spread that involves buying a call option with a lower strike price and selling a call with a higher strike price. This effectively caps your maximum potential gains but also limits your risk, since the total premiums spent are subsidized by the written call contract.

Straddles and strangles

Straddles and strangles are two-leg option strategies designed to capitalize on market volatility. With a straddle, you buy both a call and a put option at the same ATM strike price, while a strangle involves buying a call and a put at different strike prices.

• Example: Let's say you anticipate major news that could move the price of Bitcoin drastically but aren't sure in which direction. A straddle would allow you to benefit from a large move either way.

Iron condors

An iron condor is a four-leg complex option strategy that tends to benefit from low volatility. It involves first selling a strangle and collecting some option premiums. Then, you round out the multi-leg option strategy by buying a wider strangle to protect against sharp market moves.

• Example: If you believe Ether’s price will remain stable, you can sell a call and a put option at strike prices above and below the current market price. You’d then buy a protective strangle with wider strike prices to limit any extreme losses. The goal here is to make gains from the premium collected on the options you sold as long as ETH prices stay within a certain range.

Best practices for beginners in multi-leg crypto option strategies

Start small

For beginners, starting with simpler strategies like vertical spreads is advisable. This allows you to familiarize yourself with the dynamics of multi-leg options without taking on excessive risk. As you gain confidence, you can explore more advanced strategies like iron condors or butterflies.

Keep track of fees

Multi-leg strategies involve multiple transactions, so it's crucial to account for fees. Options trading fees can accumulate quickly, especially when you're executing several legs in a trade. Make sure to review the fee structure of your platform and incorporate it into your risk calculations.

Use risk management tools

From stop-loss and take profit orders to trailing stop orders, make use of such risk mitigation tools to limit your potential options losses if the market moves against you.

Avoid trading on emotions

Given the volatility that can come with crypto options trading, it's key to pick multi-leg option strategies that fit with your personal risk tolerance and trading plan. Some crypto option traders may be more comfortable with strategies that are quick to expire than others. As such, avoid making impulsive trading decisions based on fear or greed.

Educate yourself on crypto option mechanics

Given the vastness and complexity of crypto options, there are plenty of mechanics to sift through before you're considered an expert in trading these derivatives. This can range from concepts like strike prices and expiration dates to time decay and volatility skews.

Final words and next steps

Multi-leg crypto options strategies are an excellent way for traders to enhance their risk management while maximizing the potential for gains in a highly volatile market. By understanding different strategies like vertical spreads, iron condors, and straddles, you can tailor your trades to your market outlook. As always, it’s important to start with small, manageable trades and continuously monitor your positions. With the right approach, multi-leg crypto options can become a powerful tool in your trading arsenal to adapt to the ever-changing crypto market conditions, so you can potentially make steady gains while keeping your risk exposure low.

Keen to read more on crypto option strategies? Check out our guide to the options wheel strategy and the possibility of delta neutral hedging. Alternatively, if you're keen on getting started with trading crypto option strategies, check out the best platforms for trading crypto options.