Ether’s (ETH) $10,000 Dec. 31 call options recently came under the spotlight after surpassing $15.2 million in open interest (8,400 contracts). These instruments give the buyer the right to acquire Ether at a future date for a fixed price and the seller is obliged to honor it.
For this right, the buyer pays an upfront fee (premium) to the call option seller. For this reason, call options are deemed neutral-to-bullish as they give its buyer the possibility of high leverage with a little upfront investment. This ‘right’ is currently being traded for $263, equivalent to 14% of the underlying Dec. 31 ETH futures price.
Only buying the $10,000 ETH call options could be deemed a risky bet, or as the WallStreetBets Reddit users call it, a “YOLO” trade. The problem is that longer-expiry options usually involve multiple strike prices or calendar months.
For example, on Jan. 10, a spread trade occurred involving 1,500 ETH call option contracts for Sep. 24 with an $8,000 strike and 1,500 calls for Dec. 31 with a $10,000 strike.
Paradigm, an institutional-focused OTC desk, intermediated this ‘calendar spread’ strategy, and the trades took place at Deribit exchange. Unfortunately, there’s no way to know which side the market maker was, but considering the risks involved, one should assume the client was looking for a bullish position.
By selling the September call option and simultaneously buying the more expensive December call, this client paid an estimated $80,000 premium upfront, and this amount represents their max loss. According to the simulation above, this client needs Ether at $3,100 or higher to recoup his investment.
Despite shooting for the stars with a potential $2.45 million net gain at $8,000 expiry, this same client would lose more than $300,000 if Ether happens to be at $14,000 on Sep. 24.
Countless strategies can be achieved by trading ultra-bullish call options, although the buyer doesn’t need to wait for the expiry date to lock in profits. Thus, if Ether happens to increase 30% in a couple of weeks, it makes sense for this ‘calendar spread’ holder to unwind their position.
As shown in the example above, if Ether’s September futures price increases by 25% in thirty days, the buyer can lock in over $60,000 net profit by closing the position.
This effect happens because the longer-term December $10,000 call option will increase more than the September option at $8,000. Assuming that $10,000 call options buyers are effectively expecting these prices is naive.
While it’s exciting to see exchanges offering massive $10,000 to $100,000 2021 expiries, these figures should not be taken as authentic analysis-backed price estimates. Do professional traders use these instruments to conduct bullish investment strategies?
Yes.
But they don't YOLO into highly speculative trades.
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