Cryptocurrency markets are known for their high levels of volatility, with prices fluctuating significantly over short periods of time. This volatility can be intimidating for some investors, as it can be difficult to predict which direction the market will move.
However, it also creates opportunities for those looking to make money without taking on directional bets. In this article, we’ll explore a few strategies for how to make money on crypto volatility in more detail.
1. Trade options
Options are financial instruments that give the holder the right, but not the obligation, to buy or sell a cryptocurrency at a predetermined price on or before a certain date. By buying options, traders can profit from the price movements of a cryptocurrency without actually owning the underlying asset. Options can be used to hedge against potential price swings or to speculate on the direction of the market.
There are two types of options: call options and put options. A call option gives the holder the right to buy a cryptocurrency at a specific price, while a put option gives the holder the right to sell a cryptocurrency at a specific price. The predetermined price at which the option can be exercised is the strike price.
For example, let’s say you believe that the price of Bitcoin is going to rise over the next month, but you don’t want to actually buy Bitcoin because you think it’s too risky. You could buy a call option on Bitcoin instead, which would allow you to profit from the price increase without actually owning the asset.
If the price of Bitcoin goes up, you can exercise your option and buy Bitcoin at the lower strike price, and then sell it at the higher market price for a profit. On the other hand, if the price of Bitcoin goes down, you can simply let the option expire and you won’t lose any money.
Options are typically traded on exchanges, and the price of an option is determined by supply and demand. The price of an option is made up of two components: the intrinsic value and the time value. The intrinsic value is the difference between the strike price and the current market price of the underlying asset. The time value is the amount of time remaining until the option expires, as well as the expected volatility of the underlying asset.
The time value of an option is also known as the option’s premium. It represents the amount that an option buyer is willing to pay for the right to buy or sell an asset at a specific price on or before a certain date. The premium is higher for options that are further in the money (meaning the underlying asset’s market price is above the strike price for a call option or below the strike price for a put option) and for options that have longer expiration dates.
Options can be a useful tool for traders looking to profit from crypto volatility without taking on significant risks. However, it’s important to note that options come with their own set of risks, and it’s important to understand these risks before diving into options trading.
Some of the risks associated with options trading include:
- Volatility risk: The value of an option is directly tied to the underlying asset’s volatility. If the asset becomes more volatile, the option’s premium will likely increase, which could result in a loss for the option holder if the asset’s price doesn’t move in the expected direction.
- Time decay risk: The time value of an option decreases as the expiration date approaches, which is known as time decay. This means that the option’s premium will decline over time, even if the price of the underlying asset remains unchanged. This can result in a loss for the option holder if the option is not exercised before it expires.
- Liquidity risk: The options market can be less liquid than the underlying asset market, which means that it may be difficult to find a buyer or seller for an option when you want to trade it. This can result in wider spreads (the difference between the bid and ask price) for options, which can eat into profits or increase losses.
It’s important to carefully consider these risks and to only trade options if you have a solid understanding of the underlying asset and the options market. It’s also a good idea to use stop-loss orders, which can help limit potential losses and diversify your portfolio by trading a variety of options on different assets.
2. Use futures contracts
A futures contract is an agreement to buy or sell a cryptocurrency at a future date at a predetermined price. Like options, futures allow traders to take advantage of price movements without owning the underlying asset. However, unlike options, futures contracts have expiration dates and require traders to either buy or sell the underlying asset at the agreed-upon price.
Futures contracts are typically traded on exchanges, and the price is determined by supply and demand. The buyer of a futures contract agrees to buy the underlying asset at a specific price on a specific date in the future, while the seller agrees to sell the asset at that price on that date.
For example, let’s say you believe that the price of Ethereum is going to rise over the next few months. You could buy a futures contract on Ethereum, agreeing to buy the asset at a specific price on a specific date in the future. If the price of Ethereum goes up before the contract expires, you can profit by buying the asset at the lower price agreed upon in the contract and selling it at the higher market price. On the other hand, if the price of Ethereum goes down, you’ll be required to buy the asset at the higher price agreed upon in the contract, potentially resulting in a loss.
Futures contracts can be a useful tool for traders looking to profit from crypto volatility without taking on significant risk. However, it’s important to note that futures contracts come with their own set of risks, and it’s important to understand these risks before diving into futures trading.
Some of the risks associated with futures contracts include:
- Credit risk: When you enter into a futures contract, you are entering into a legal agreement with the counterparty on the other side of the trade. If the counterparty defaults on the contract, you could be at risk of losing money. To mitigate this risk, most futures contracts are settled through a clearing house, which acts as a third party and guarantees the performance of both parties.
- Market risk: The value of a futures contract is directly tied to the price of the underlying asset. If the price of the asset moves in the opposite direction of what you were expecting, you could end up losing money.
- Volatility risk: Similar to options, the value of a futures contract is affected by the underlying asset’s volatility. If the asset becomes more volatile, the futures contract’s value could fluctuate significantly, which could result in a loss for the holder.
It’s important to carefully consider these risks and to only trade futures contracts if you have a solid understanding of the underlying asset and the futures market. It’s also a good idea to use risk management techniques, such as stop-loss orders, and to diversify your portfolio by trading a variety of futures contracts on different assets.
3. Implement a pairs trading strategy
Pairs trading involves buying and selling two correlated cryptocurrencies in an effort to profit from the price differential between them. This strategy is based on the idea that the prices of two correlated assets will eventually converge, and traders can profit by taking advantage of the price differential between them.
For example, if Bitcoin and Ethereum have historically moved in the same direction, a trader might buy Bitcoin and sell Ethereum when the price differential between the two widens. If the price differential narrows, the trader can buy Ethereum and sell Bitcoin, potentially realizing a profit. This strategy can be profitable even if the overall market is not moving in a particular direction.
To implement a pairs trading strategy, traders need to identify two cryptocurrencies that are correlated and track the price differential between them. This can be done manually by tracking the prices of the two assets and calculating the price differential, or it can be done using specialized software that automatically tracks the price differential.
Pairs trading can be a complex strategy, and it’s important to have a solid understanding of the underlying assets and the market dynamics before attempting it. It’s also a good idea to backtest the strategy using historical data to see how it would have performed under different market conditions.
It relies on the assumption that the prices of the two correlated assets will eventually converge. If the prices do not converge as expected, traders could end up losing money. To minimize this risk, traders can use risk management techniques such as stop-loss orders and diversify their portfolio by trading a variety of pairs.
4. Use arbitrage opportunities
Arbitrage refers to the practice of buying and selling a cryptocurrency on different exchanges or in different countries in order to profit from price differences. This can occur due to a variety of factors, such as differences in the supply and demand for a cryptocurrency on different exchanges or differences in the regulations governing the sale of cryptocurrencies in different countries.
For example, if Bitcoin is selling for a lower price on one exchange compared to another, a trader could buy it on the cheaper exchange and sell it on the more expensive one, pocketing the difference. Arbitrage can also occur between different countries if the price of a cryptocurrency is lower in one country compared to another due to differences in demand or regulations.
Arbitrage opportunities can be difficult to identify and take advantage of, as they often require traders to have accounts on multiple exchanges and to move funds between them quickly. It’s also important to consider the costs of trading, such as fees and taxes, as these can eat into potential profits.
5. Stabilize your portfolio with stablecoins
Stablecoins are cryptocurrencies that are pegged to a stable asset, such as the US dollar, in an effort to reduce price volatility. These stablecoins are designed to maintain a stable value, regardless of the movements of the underlying asset.
Holding a portion of your cryptocurrency portfolio in stablecoins can help stabilize your overall portfolio and minimize the impact of market volatility. For example, if the price of Bitcoin suddenly drops, the value of your portfolio could also drop significantly. However, if you have some of your portfolio invested in a stablecoin, the value of your portfolio will be less affected by the price movements of Bitcoin.
There are several different stablecoins available, each with its own characteristics and risks. Some stablecoins are backed by physical assets, such as gold or real estate, while others are backed by fiat currencies, such as the US dollar or the euro. It’s important to thoroughly research the different stablecoins available and understand their risks before investing.
Some risks associated with stablecoins include:
- Credit risk: Some stablecoins are issued by companies, and the value of the stablecoin is dependent on the creditworthiness of the issuer. If the issuer defaults on its obligations, the value of the stablecoin could drop.
- Volatility risk: Even though stablecoins are designed to maintain a stable value, they can still be affected by market volatility. For example, if there is a sudden drop in the value of the underlying asset, the value of the stablecoin could also drop.
- Liquidity risk: The stablecoin market can be less liquid than the underlying asset market, which means that it may be difficult to buy or sell large amounts.
Conclusion
In conclusion, there are several strategies that traders can use to make money on crypto volatility without taking on directional bets. Options, futures contracts, pairs trading, arbitrage, and stablecoins are all potential strategies for traders looking to profit from crypto volatility. However, it’s important to note that these strategies come with their own risks and may not be suitable for all investors. It’s always a good idea to thoroughly research and understand the risks before diving into any new investment strategy.
