In my last post (which you can find here) I talked about LedgerX and how they offered option trading for BTC as well as futures and other services. Today I'm going to explain a simple option strategy I'm bringing over from stock trading to this market, called The Wheel, that you can use to make extra income on your Bitcoin holdings or pick up some BTC at a discount to market prices.

The Wheel

The wheel is considered a passive trading strategy used by those looking to earn additional income on their assets while limiting risk and requiring a small amount of time to monitor. It's a patient strategy, designed to work whether the market goes up and down and still have the ability to make a profit or at the very least leave the trader with something to work with to generate future income. The only two things that are required are volume and volatility. As long as there are traders interested in the asset and they have different opinions on how much that asset should be worth, the wheel will keep spinning.

So how do we start? Well first we need an asset, either BTC or cash.

The most common start to the wheel strategy is the selling of a Put option contract, using their cash as a collateral against the contract. Remember, with puts if you're selling the contract you will only get forced to purchase the Bitcoin with your collateral at the end of contract if the price of Bitcoin is below the strike price, and that's only if the owner of the contract executes it. LedgerX runs their options contracts European style, which means they can only be exercised at expiration.

Let's take a look at LedgerX's trade screen:

If we look at the options expiring February 26, 2021, about 10 weeks out from the writing of this post, we can see that the 15,000 strike is going for between $888-$1,000 per full BTC. Looking up top we can see this contract is "out of the money" (OTM) by a bit over $3,000 at this moment in time, which is significant but knowing Bitcoin's history not out of the realm of possibility (the 300+ open contracts listed to the far right of that line show us there is at least some belief that it could happen in the market, or at least a desire to hedge against it).

Now on the 20,000 strike we see the prices spike to average around $3,000 because this strike is "in the money" (ITM) and therefore has some intrinsic value since the currently price for BTC is below this strike price. Now if you do some quick math you might realize it's still possible to make a profit from this contract at current values, but it would involve a lot more risk then this strategy is designed to have so we're going to stick with the 15,000 strike for now.

On the left you can see the order book for this contract, with the Bid side listing what those looking to buy put contracts are willing to pay and what those looking to sell contracts are asking for. Note that while all prices are listed for a full BTC, a single contract represents 0.01 BTC. That means that the highest bidder here is looking to buy up to 0.75 BTC for $8.88/0.01 BTC. If you get confused just remember when looking at contract amounts and prices move the decimal two to the left to figure out how much BTC and $/0.01 BTC you're looking at.

Two more things I'd like to point out; Implied Volatility and Delta.

Implied Volatility is a measurement of what the market thinks are the chances of movement in a securities price based on different factors and mathematical formulas I won't get into here. Now this movement could be up and/or down, the direction is irrelevant. What matters is the chance that there will be a move in some direction, and the bigger the chance that something might happen the more we can charge in premiums! While Implied Volatility shouldn't be the only thing you look at when deciding on a contract to sell, it can help decide when to commit for the best payday possible.

Delta denotes the average expected change in the premium cost for each $1 that BTC would increase. Remember that all prices are listed based on 1 BTC, so for just one contract (0.01 BTC) this would be -0.0023 which....isn't much. Now this is negative here because Put contracts lose value as the asset they're based on gain value. With the significant spread between the Bid and Ask that exists here this won't really have a huge affect on premiums until there's a very large move on Bitcoin's part, but it is something to consider when deciding on what to ask for premium wise and how your contract can change as BTC moves.

Now, I think we can do a little better than the current top bid so lets offer to sell 1 contract at $900/1 BTC:

So here I've put a 1 in the Contract box up above, $900 in the Price box and hit "Sell". In the confirmation screen we can see we're about to commit to buying 0.01 BTC at a price of $150 (hence why we'd be locking $150 worth of USD), and in exchange we'll collect $9 in premium which we keep no matter what happens. If that seems pretty low considering what we're locking up keep in mind you'd have to find someone paying around 30% APY to make $9 in the time frame we're covering with this contract.

I want to point out the Break Even and Max Loss lines for a moment as now we're getting into the risk side of things with this part of the strategy. I'll do Max Loss first because while that might look scary when compared to your max gain, this could only happen if Bitcoin fell to 0. While another large drop is always possible I think we're well past the point that the premier cryptocurrency could become worthless save for massive worldwide government intervention.

As for Break Even its pretty straight forward; its the price BTC would have to be at if this contract executed where you could immediately sell the BTC you just bought and break even overall. However, even this doesn't matter as much for our Wheel strategy because the goal here isn't to buy BTC through a put and then immediately sell it. It's to get our Cost Basis as low as possible until we end up finally getting assigned on a contract and made to purchase the Bitcoin.

You see, every dollar we collect in premium from selling puts reduces how much we would eventually pay overall for the Bitcoin we're agreeing to buy through our contracts, which becomes our cost basis for the amount of BTC we just got. If we manage to sell multiple put contracts in a row before one finally ends ITM, we might "lose" on that trade but still be ahead overall or at the very least down a lot less then our last trade might suggest. Either way we've just set ourselves up for where the Wheel really makes money; selling a Call.

Get the Wheel spinning

So now that we have our newly acquired Bitcoin (or old Bitcoin if you decided to start the Wheel here instead of with cash), we go to the Call side of the ledger and start looking at selling a contract for it.

So the set up is pretty much the same as with our Puts, save for now strikes below the current price are ITM. You'll note that Delta is also positive as now BTC going up in value makes our contracts more likely to be in the ITM and therefore more valuable. Now the plan at this point is simple: pick a strike price above your current cost basis, which the premium from selling this call will also help, for an expiration date you're comfortable with and set your premium.

The best part of the Wheel when executed correctly is that you'll always be in a position to make money no matter wha........you stopped reading as soon as you saw that Max Loss: Unlimited, didn't you?

Take a breath and relax, that max loss is actually a bit misleading. Yes, in theory the price of BTC could go up into numbers I'm not motivated enough to write out, but in reality you know it's likely to fall within a certain range given the time frame of your contract. Besides, this is only a loss of potential earnings that you would have had if you had held onto your coins instead of selling the Call. If you've sold at a strike that's above your cost basis, then whether the option expires in or out of the money you will profit!

So what do we do once we have a Call option assigned and we sell our BTC for cash?

Well, its called The Wheel for a reason, folks. As long as there's still a market and the price of Bitcoin hasn't flat-lined its time to sell another Put contract. If you're luck and managed a hefty profit from your Call you can now try and sell two more contracts if you can cover the increased collateral for them. This is how the Wheel strategy starts to accelerate and create more and more passive income.

A Final Word On Risk

If you remember at the beginning of this post I mentioned how this strategy was designed to limit risk. While this is true, note I said limit and not eliminate. With any kind of trading there will be the chance of losing real money and it's no different here.

While there is the chance of missing out on Bitcoin going on a huge bull run and no longer being able to afford to back a Put contract to maintain the strategy, the biggest threat to losing money is if Bitcoin were to crash again. This would cause problems whether you were on the Call or Put side of the Wheel at the time as either way you'd now have coins who's cost basis is well below the current market price.

Now you could still make up for this by selling Calls as before, but you'd likely be stuck selling contracts that are well OTM. These are not going to net you very much premium and will mean a long period of time to claw your way back to profitability unless Bitcoin were to rally again. A patient trader could eventually recover from this unless something earth-shattering happens in the world of crypto, but you must decide for yourself if you're comfortable with this kind of risk before pursuing this kind of strategy.

As always, you should think about your financial goals and acceptable risks before pursuing any kind of investment and I encourage you to research and even practice trades on paper before committing real assets.

I'm open and appreciate any comments or questions you might have and will try to answer as best as I can. If you have any suggestions on what I should cover next please drop a comment below!