An ‘exploding crush’ is a type of options trading strategy commonly used in Asia. It involves selling call options and put options with different strike prices and then buying a call option with a lower strike price and a put option with a higher strike price. Trade is initiated when the underlying asset is at or near the middle of the strike prices of options.
The advantage of this strategy is that it allows traders to take advantage of different market conditions. If the underlying asset rises in value, the call option will increase while the put option will decrease in value. If the primary asset falls in value, the reverse will happen. Traders can trade in both scenarios.
What are the advantages of using this strategy?
The most significant advantage of using this strategy is that it can help traders profit from both rising and falling markets.
- This strategy is relatively simple to execute and does not require much capital.
- The risk involved in this strategy is limited to the premium paid for the options.
- You can use this strategy to earn money or speculate on the market’s direction.
How can this strategy be used?
You can use the exploding crush strategy in various ways. One way is to initiate the trade when the underlying asset is at or near the middle of the strike prices of the options sold. Another way is to use this strategy as part of a hedging strategy.
For example, if a trader has a long position in an underlying asset, they could use this strategy to hedge their position. It would involve selling a call option with a strike price above the asset’s current market price and buying a put option with a strike price below the current market price. If the asset decreases, the trader will offset some of their losses with the profits from the put option.
Traders can also use this strategy to speculate on the market’s direction. For example, if a trader believes that the market will fall, they could sell a call option with a strike price above the current market price and buy a put option with a strike price below the current market price. If their prediction was correct and the market fell, they would make a profit.
What are the risks of using the exploding crush strategy?
A move in an unfavourable direction
The most obvious risk is that the underlying asset may move unfavourably to the position. For example, if a trader sold a call option with a strike price of $100 and bought a call option with a strike price of $90, they would expect the underlying asset to rise in value. However, if the asset instead fell to $85, they would lose money on the trade.
Volatility
Another risk is that the underlying asset may become more volatile than expected. It can have many different effects on the trade. First, it may cause the options to move out of the money, meaning that the trader will not be able to take advantage of the price difference. Second, it may cause the options to move closer to expiry, which will reduce the time available for the trade to work out.
Time decay
Time decay is the amount by which the value of an option falls over time. It is a particular risk in this strategy because traders need to be confident that the price difference between the two options will remain in place until expiry. If it does not, they may find that their position starts to lose money.
Counterparty risk
Another risk to consider is counterparty risk, which is that the other party to the trade will not fulfil their obligations. For example, if a trader buys a call option from a broker, they trust that the broker will payout if the option expires in the money. However, if the broker goes bankrupt before expiry, the trader may not receive their payout.
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