Leverage and hedging strategies are powerful ways to use derivative contracts, but traders typically make these three main mistakes.
Beginning traders are generally attracted to the futures and options markets because of the promise of high returns. These traders see influencers post unbelievable profits and at the same time the various 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 the dream of outsized profits into a nightmare and an empty account. Even experienced investors in the traditional markets fall victim to problems, especially in the cryptocurrency markets.
Cryptocurrency derivatives work in a similar way to traditional markets, as 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 The contract cannot be transferred across different exchanges, nor can it be withdrawn.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 bitcoin option contracts
, so the gains or losses vary according to fluctuations in the price of the asset. Option contracts also provide the right to buy and sell at a later date for a predetermined price. This gives traders the ability to generate leverage and hedging strategies.
Let’s examine three common mistakes to avoid when trading futures and options.
Convexity can kill your 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. As the price of Bitcoin increases, the investor’s margin increases in US dollar terms, allowing for additional leverage.
The problem arises when the opposite movement occurs and the price of BTC collapses; consequently, the user’s deposit margin falls in US dollar terms. Traders often get overly excited when trading futures contracts, and positive tailwinds reduce their leverage as the BTC price rises.
The main thing is that traders should not increase positions solely because of the delivery caused by the increase in the 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, and some offer isolated margin for perpetual and monthly contracts. Traders have the option to choose between cross-security, which means that the same deposit serves different positions or is isolated.
There are advantages to each option, but beginner traders tend to get confused and liquidated due to the absence of proper management of margin deposits. On the other hand, isolated margin offers more flexibility to bear risk, but requires additional maneuvering to avoid excessive liquidations.
To solve this problem, you should always use cross margin and manually enter your stop loss on every trade.
Please note that not all options markets are liquid.
Another common mistake is trading in illiquid options markets. Illiquid options trading increases the cost of opening and closing positions, and options already have built-in fees due to the high volatility of crypto.
Options traders must ensure that the open interest is at least 50 times greater than the number of contacts desired to trade. Open interest represents the number of outstanding contracts with strike price and expiration date that were previously bought or sold.
Understanding implied volatility can also help traders make better decisions about the current price of an option contract and how it might change in the future. Remember that the price of an option rises along with higher implied volatility.
The best strategy is to avoid buying calls and puts with excessive volatility.
It takes time to master derivatives trading, so traders start small and test every feature and market before making big bets.