Because of the high return promise, novice traders often gravitate to options and futures markets. They watch influential traders post amazing gains and, at times, they find the numerous advertisements for derivatives exchanges offering 100x leverage irresistible.
While recurring derivatives contracts can increase traders’ gains, there are a few things that can make the dream of huge gains quickly into nightmares and empty accounts. Even the most experienced investors in traditional markets can fall prey to problems specific to cryptocurrency markets.
Because buyers and sellers are dependent on the underlying asset, cryptocurrency derivatives work in a similar way to traditional markets. It cannot be transferred between exchanges or withdrawn.
Options contracts are priced in Bitcoin ( Bitcoin) or Ether ( Ethereum). The gains and losses will change according to asset price fluctuations. Options contracts allow you to purchase and sell at a future date at a predetermined price. This allows traders to create leverage and hedge strategies.
Let’s look at three common mistakes to avoid when trading options and futures.
Your account can be destroyed by convexity
Convexity is the first problem traders will face when trading cryptocurrency derivatives. This is where the margin deposit’s value changes as the price of the underlying asset fluctuates. The margin deposit increases in U.S. dollars as Bitcoin prices rise, which allows for additional leverage.
When the BTC price falls, this is when the issue arises. Users’ deposited margins decrease in U.S. dollars terms. When trading futures contract, traders often get too excited. As BTC prices rises, positive headwinds decrease their leverage.
The key takeaway here is that traders shouldn’t increase their positions due to the delivery of increasing margin deposits.
There are benefits and risks to isolated margin
Users must transfer funds from their regular spot accounts to derivatives exchanges. Some will provide an isolated margin for perpetual or monthly contracts. Cross collateral allows traders to choose between multiple deposits or one that serves only one position.
Each option has its advantages, but novice traders often get lost and end up liquidating their margin deposits. However, isolated margin allows for greater flexibility in supporting risk but requires extra maneuvers to avoid excessive liquidations.
This issue can be solved by using cross margin and manually entering the stop loss for every trade.
Not all options markets have liquidity
Trading illiquid options markets is another common error. Trading illiquid options increases the cost of opening and closing positions. Options already have embedded costs due to crypto’s volatility.
Options traders must ensure that the open interest is at minimum 50x the number contacts they wish to trade. Open interest is the number of contracts that are still open and have an expiration date and strike price.
Trading can be made easier by understanding implied volatility. This will allow traders to make better decisions about future options prices and what they may change. Remember that implied volatility increases with an option’s premium.
Avoid buying volatile calls and puts.
Trading derivatives takes time. Therefore, traders need to start small and learn each market before placing large bets.
These views and opinions are the author’s and do not necessarily reflect those of Cointelegraph.com. You should do your research before making any investment or trading decision.