Selling Covered Calls - A Bitcoin Options Strategy

A Hodler’s guide for a bit of Bitcoin income.
Hodlers of bitcoin are a different type of investor than most. They are quite happy to hold bitcoin even when it is falling in value and actually relish the lower prices because it means that they can buy even more bitcoin at a lower price (stacking sats).
Selling covered call options is a way to put your bitcoin to work and can be a source of yield. With covered calls you trade a stream of Bitcoin income for the exposure to the potential parabolic up-moves that people expect and will pay for in Bitcoin.

The TL;DR strategy:
Own some amount of bitcoin then write (sell) call options on that same amount of bitcoin, far enough Out of The Money to not be hit, to generate a bitcoin income.

Large holders of stock often employ this strategy to give their income a nice boost from the options premium if they do not expect the price to increase too much in the near-term.
The trader of covered calls in the stock market is willing to forego the gains above the selected option’s strike price, in return for regular income in the form of option premiums. The trader is sacrificing part of their ownership in a company which they are okay with as they have made money with the price appreciation at that point.
Selling covered calls is seen as a conservative strategy because there is no leverage involved. The seller collects the premium and the keeps the Bitcoin that was put up as collateral so long as the price doesn’t reach the strike price.
Covered calls are a neutral strategy, they are best used in times when a trader believes that bitcoin is unlikely to either increase or decrease in price too much. Although in bitcoin many hodlers prefer to hold, even if the BTC price is down dramatically.

You should only sell a covered call if you are happy to actually sell at the strike price. Relinquish some of your ownership of BTC in return for dollar gains. In the meanwhile, you collect premiums (in BTC) all the way to the target price.

How it works….


Setting up the trade:
Let’s say you are a long-term hodler. You have 1 BTC sitting around not doing much. There is a way to put that Bitcoin to work.
First, deposit this 1 BTC to Deribit, this is the collateral for the trade.
Now sell an Out of The Money (OTM) call for a premium, far enough out that you think it will not be hit within the timeframe of the option.
This strategy can be done continuously (weekly or monthly for example), you collect the premium and keep your full staked amount so long as the spot price of Bitcoin doesn’t reach the Strike price of the call option before the expiry.
The ‘covered’ part of the covered call is when you own the underlying asset, in this case, bitcoin. If you don’t own any bitcoin then selling a call would be a ‘naked’ strategy. Naked strategies are decidedly more risky!

 

What happens at expiry….

There are 2 ways this can play out:
1. The bitcoin price stays below the strike price (the option is not exercised)
The contract that you sold expires worthless. You keep the 1 BTC and the premium that you sold the contract for.
2. The price price is above the strike price (the option is exercised)
The contract that you sold will now be exercised (Deribit exercises in-the-money options automatically). You will have made a gain in USD but you have had to give up any gains you would have gotten above the chosen strike price in the call option that you sold.
The worst-case scenario for a hodler selling covered calls is that the price of Bitcoin breaks above the strike price of the call option and you end up selling your BTC at that strike price.

Bitcoin selling OTM call

The Deribit Position Builder can help you see what your expected profit/loss will be at the time of expiration.

Covered Call on Deribit [an example]

Example:
1 – You own 1 BTC
2 – Deposit that 1 BTC as collateral
3 – Bitcoin is trading at ~ $9400
4 – Sell the [BTC 25SEP20 1600 C] (Bitcoin Call Option with strike price of $1600, expiring on the 25th of September 2020 (118 days until expiry).
5- Current Mark price for that Call is 0.0372 BTC (~ $360 currently)
6 – If you are able to sell a covered call like this every 118 days (like this example), then the yield from selling an option like this is ~10% per year in BTC.

 

Selling Bitcoin Covered Calls Options

The scenarios at expiry:
1 – Bitcoin price remains at or below the strike price ($1600) – you now have 1.0372 BTC , the value in USD depends on the price of Bitcoin on that day.
2 – If the price of BTC is the same at $9400, your stake + premium is now worth ~ $9760
3 – If BTC went down to $7000, your 1.0372 BTC is worth ~ $ 7260 (you are up in BTC but down in USD)
4 – If BTC Moons past your OTM strike price and is at $20000 at expiry then you will have to sell your bitcoin for the agreed upon price of $16000 and you would still have your 0.0372 premium at $20000 (~ $ 744)
So you have ~ $ 16744. You are up in USD but down in BTC, as at $20000, $ 16744 would only buy you back just shy of 0.84 BTC.
Ideally then with this strategy in place, bitcoin would move up to the strike price and go no further higher until after expiry and you choose another OTM call to sell for the next period.