The journey for Bitcoin investors back to all-time highs hasn’t been an easy one. But the world’s largest cryptocurrency by market capitalization has been on a tear since bottoming out in early April. Bitcoin continues to hover near the $100,000-level and looks poised to retest the highs from last year.
Outside of owning crypto outright, several stocks are making waves in conjunction with Bitcoin’s ascent.
Coinbase COIN, the largest U.S. cryptocurrency exchange, has been a big beneficiary of the latest move. The company offers the primary financial account in the crypto economy, including a brokerage platform with a pool of liquidity for both institutions and retail investors. In addition, Coinbase offers a suite of products granting access to build on-chain for developers.
Earlier this month, Coinbase acquired Dubai-based Deribit, a major cryptocurrency exchange for $2.9 billion. It marked the largest deal in the crypto industry to date. The acquisition will boost Coinbase’s position as an international leader in crypto derivatives.
COIN, currently a Zacks Rank #3 (Hold), has exceeded the earnings mark in each of the past 9 quarters. Last week, Coinbase reported first-quarter earnings $1.94 per share, beating the Zacks Consensus Estimate by 4.9%. The company has delivered a trailing four-quarter average earnings surprise of 32.7%.
A leading crypto exchange, Coinbase boasts several tailwinds including investments in infrastructure and expanded partnerships such as Stripe. Coinbase will officially be added to the S&P 500 later this month.
While there are many ways to take advantage of a bullish move in COIN shares, options provide us with flexibility, enabling us to tailor our strategy to the current market environment.
Option spreads are extremely effective in this type of environment. Call option debit spreads are implemented by purchasing a call option and selling a related call option with a higher strike price. These types of trades are limited risk trades because the short option is ‘covered’ by the option purchase.
When done correctly, trading options provides huge profit opportunities with limited risk, making options one of the most versatile investment vehicles.
Option Essentials
Before we analyze today’s trade, let’s review some option fundamentals as a refresher. There is no need to worry about complex mathematical formulas or equations. Over the years I’ve found that the more complicated a strategy is, the less likely it is to work over the long run.
Options are standardized contracts that give the buyer the right – but not the obligation – to buy or sell the underlying stock at a fixed price, which is known as the strike price. A call option gives the buyer the right to buy a particular security, while a put option gives the buyer the right to sell the same. The investor who purchases an option, whether a put or call, is the option buyer, while the investor who sells a put or call is the seller or writer.
These contracts are valid for a specific period of time which ends on expiration day. There are weekly options, monthly options, and even LEAPS options which are longer-term options that have an expiration date of greater than one year.
Options consist of time value and intrinsic value. In-the-money options consist of both components; at-the-money and out-of-the-money options consist only of time value. At options expiration, options lose all time value.
Below we’re going to explore a call option spread strategy.
The Power of Option Spreads
Coinbase currently meets our criteria for initiating a bullish call option spread position.
The table below displays the risk/reward profile for this trade. COIN is trading at $266.58/share at the time of this writing. This trade involves purchasing the June 220-strike call at 51.9 points, and selling the June 240-strike call at 37 points for a total cost of 14.9 points. As option contracts represent 100 shares of the underlying security, this would represent a total cost of $1,490 per spread (orange box).
Zacks Investment Research
Image Source: Zacks Investment Research
The top (blue) row in the lower section shows the performance of COIN stock based on different percentage scenarios at expiration. The last (purple) row shows the corresponding percentage return for our debit spread trade. We can see that regardless of whether COIN increases in price, remains flat, or even loses 10% from our entry, our option spread trade will produce a roughly 34% return.
These are types of odds I like to have in my favor when trading options.
Advantages of Spread Trading
1) The Option Sale Provides Downside Protection
The sale of a call option results in cash being credited to your brokerage account. This reduces the cost basis of the option purchase and provides downside protection in the event the price of the underlying stock declines.
2) Risk is Reduced
In the COIN trade just presented, the sale of the 240-strike call reduced the risk of the 220-strike purchase from $5,190 to just $1,490 per contract.
3)Allows Us to Maintain Positions During Volatile Markets
The downside protection provided by the call option sale helps us maintain our spread trade during heightened volatility. Naked option purchases may force us to sell early in order to prevent large losses.
4) Spreads Can Be Profitable If Stock Goes Up or Down
Option spreads can be profitable even if the underlying stock decreases or remains flat, providing us with an entirely new dimension of money-making opportunities.
Bottom Line
The call option spread strategy is an excellent way to profit during periods of high market volatility. Remember that the call option sold through this strategy profits as the price of the underlying stock declines, providing us with a cushion during market pullbacks.
Option spreads are a safe way to use the leverage inherent in options. Your risk is limited to the price paid for the spread. Volatile markets don’t have to be scary; instead, they can present a great opportunity to profit!
Disclosure: The Zacks Headline Trader service currently holds a position in Coinbase.
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