Beginning traders are often drawn to the futures and options markets because of the promise of high returns. These traders see influencers post incredible profits and at the same time, the multiple advertisements of derivatives exchanges offering 100x leverage are sometimes irresistible to most.
Although traders can effectively increase profits with recurring derivative contracts, a few mistakes can quickly turn dreams of huge profits into nightmares and an empty account. Even experienced investors in the traditional markets fall victim to the problems of the cryptocurrency markets.
Cryptocurrency derivatives work similarly to traditional markets in that buyers and sellers enter into contracts that depend on an underlying asset.. The contract cannot be transferred across different exchanges, nor can it be withdrawn.
Most exchanges offer option contracts priced in Bitcoin (BTC) and Ether (ETH), so profit or loss will vary based on fluctuations in the asset price. Options contracts also offer the right to buy and sell at a later date for a predetermined price. This offers traders the ability to create leverage and hedging strategies.
Let’s investigate three common mistakes to avoid when trading futures and options.
Convexity can kill your own account
The first problem traders face when trading cryptocurrency derivatives is called convexity. In this situation, the margin deposit changes its value as the price of the underlying asset fluctuates. When the price of Bitcoin rises, the investor’s margin rises in US dollar terms, allowing for additional leverage.
The problem arises when the opposite movement occurs and the price of BTC crashes; consequently, the margin deposited by users decreases in US dollar terms. Traders often get overly excited when trading futures contracts, and positive headwinds reduce their leverage as the BTC price rises.
The main takeaway is that traders should not increase their positions solely due to delivery caused by the increasing value of margin deposits.
Isolated margin has benefits and risks
Derivatives exchanges require users to transfer funds from their regular spot wallets to futures markets, with some offering isolated margin for perpetual and monthly contracts. Traders have the option to choose between cross collateral, which means that the same deposit is used for multiple positions or is isolated.
Each option has its advantages, but novice traders tend to get confused and get fired for not managing margin deposits correctly. Secondly, isolated margin offers more flexibility to bear risk, but requires additional maneuvering to avoid excessive liquidations.
To solve this problem, always use cross margin and manually enter the stop loss on each trade.
Beware, not all options markets are liquid
Another common mistake is trading in illiquid options markets. Trading illiquid options increases the cost of opening and closing positions, and options already have built-in fees due to the high volatility of cryptocurrencies.
Options traders should ensure that the open interest is at least 50 times the number of contacts they wish to trade. Open interest represents the number of outstanding contracts with a strike price and expiration date that have been previously bought or sold.
Understanding implied volatility can also help traders make better decisions about the current price of an options contract and how it might change in the future. Keep in mind that an option’s premium increases when implied volatility increases.
The best strategy is to avoid buying call and put options with excessive volatility.
Trading derivatives takes time to master, so traders should start small and test every feature and market before making big bets.
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