- Bitcoin has surged in recent months, but it’s been prone to 80+% drawdowns historically.
- A collar option strategy provides bitcoin exposure with limited volatility, says CIO Jack Ablin.
- Ablin recommends investors buy an out-of-the-money put and sell a call option.
Bitcoin’s 53% price gain since the election has left early bitcoin believers celebrating their bet and crypto laggards wishing they’d bought in earlier.
The rally could continue as president Donald Trump begins his second term. He might be America’s most crypto-friendly president yet, as seen by the launch of his memecoin $TRUMP and his interest in setting up a bitcoin strategic reserve.
But bitcoin’s impressive rise also means that if the coin crashes, it’ll be quite painful for investors, especially those who bought in recently.
However, you can have both exposure to bitcoin’s upside potential and protection from downside risk, says Jack Ablin, chief investment officer at investment firm Cresset Capital.
To do this, Ablin recommends his clients use a collar option strategy when investing in bitcoin. A collar combines two trades: buying a put option and selling a call option. The put provides downside protection in the case of a price drop, while the call allows you to profit up to a certain ceiling. The premium from selling the call option can offset the cost of buying the put option, making the collar strategy low or no-cost.
“It’s a great way to tiptoe into Bitcoin without feeling like you could potentially get your head handed to you,” Ablin told BI.
How does a bitcoin collar work?
The first step to a collar trade is to own the underlying asset — in this case, bitcoin. Ablin recommends doing this through the iShares Bitcoin Trust ETF (IBIT). A bitcoin ETF is an accessible avenue to trade cryptocurrency without needing to use a crypto-specific platform or store the asset yourself.
The next step is to buy an out-of-the-money (OTM) put option, meaning the strike price is lower than the underlying asset’s current market price. If the price of IBIT falls below the strike price of the put option, you can exercise the put by selling your shares of the ETF at the strike price, providing downside protection. It’s essentially an insurance policy that guarantees you can sell your shares at a set price, even in the event of a crash.
Then, to benefit from upside — at least to a degree — sell an OTM call option. The call option in this case gives someone else the right to buy IBIT from you at the specified strike price. If the price of IBIT rises above the strike price of the option, then you are obligated to sell it for the strike price — basically at a discount. You still make a gain, but the upside is capped.
Buying a put will cost a fee, but writing a call will generate a premium that can reduce or entirely offset the fee.
So, let’s lay out an example. Assuming the cost of IBIT is $60 per share for illustrative purposes, an investor could carry out the collar strategy by buying a put with a strike price of $55 for a $2 fee. This guarantees they can sell the shares at $55 if they were to fall to, say, $40 within the set expiration period. They could also then sell a call option with a strike price of $65 and receive a $2 premium. If IBIT rises to, say, $68, they have to sell the shares for $65 a piece. They still still lock in the 8.3% jump from $60 to $65, but that’s the maximum gain they’ll see.
Ablin recommends investors who undertake this strategy to purchase options with an expiration period of one year. This provides an ample time horizon for regulatory changes or other catalysts to play out in the market.
A cautiously bullish strategy
For investors who are comfortable with limiting the upper bound of their bitcoin investment in exchange for protection from a large drawback, an option collar provides the best of both worlds.
It’s also a good strategy for investors who are looking to add bitcoin to their portfolios but don’t want to be exposed to high volatility, Ablin said.
Ablin sees plenty of benefit from a bitcoin option collar. The cryptocurrency could have a bumpy future ahead as quantum computing capabilities advance and threaten the security of bitcoin’s blockchain. That’s not to mention bitcoin’s history of multiple drawdowns in excess of 80%. All things considered, it might not be a bad idea to use a collar strategy to cap your potential losses.
