Option Break-Even Price: Definition, Examples, and How to Calculate
Cryptocurrency derivates are gaining popularity. One of them is the option contracts on Bitcoin. This tool enables traders to earn on the change in the BTC price or reduce hedge the risks.
An effective strategy is unimaginable without calculating when you break even in crypto options. We will explain below the break-even price options.
- The options break-even price, or BEP, is the point when the position covers the initial expenses.
- Strike price and premium price are the key components to calculate if you break even on options
- For the buyer, BEP is essentially the price of the option plus its premium. While for the seller, it is the price of the option with the premium deducted from it.
What Is the Break-Even Price of an Option?
The Break-even price in options is defined as the price an asset must reach for the options contract position to be considered neither profitable nor in a loss. Knowledge of the break-even price will help traders understand the state of their contracts and adjust their strategies (if need be).
For the person that buys Ethereum Options, the BEP is the price at which the options contract has enough intrinsic value to cover the money the investor paid for it, and the profit is zero. The seller has a different perspective on it. Even if the option is in the money, he can still make a profit if it has not gone above the strike price plus the premium he received for the contract.
The BEP in both buying and writing options factors two key pieces of information; the agreed-upon strike price and the premium paid to acquire the contract.
What Option Break-Even Price Depends On
There are two key components that break-even price options possess:
- The initial price of the option or premium — the money paid for the option;
- Strike price — the set price at which the option can be bought or sold, depending on whether it is a call or put option.
Break-Even Point (BEP)
In general, the breakeven price (BEP) is the amount of money an asset must sell to cover the original cost of acquiring and owning the asset. It can be applied to different types of transactions.
In the cryptocurrency industry, the break-even price is especially important in the context of Bitcoin mining. The price level at which the mining profitability equals the total costs spent on equipment and electricity is the break-even point.
Traders also use the break-even price to determine at which point the product price will cover all costs, fees, and taxes associated with its purchase.
Breakeven Point of Cryptocurrency Call Options
In cryptocurrency options trading, the breakeven point is the market price that the underlying asset must reach in order for the option buyer to avoid a loss if it is exercised. For a call option buyer, the breakeven point is reached when the underlying asset equals the strike price plus the premium paid. The break-even point usually does not include fees, although these fees can be included at the trader's discretion.
Suppose that an investor pays a premium of $100 for a call option on BTC with an exercise price of $15,000. This means that the investor has the right to buy 1 BTC at $15,000 per share at any time before the option expires. The break-even price for a call option is the $15,000 strike price plus a $100 call premium, or $15,100.
If the call option holder buys BTC at 15,000 dollars and, as the price moves, sells it at the market price of 18,000 dollars, the profit is 2,900 dollars minus the breakeven price of 15,100 dollars.
Calculating Break-Even Prices for Options Strategies
In this section, we will examine simple options strategies. Depending on the investor's objective, the strategy can be with limited/unlimited losses and/or profits. This choice is also influenced by the trader's expectations of a rise/fall in the price of the underlying asset.
For ease of understanding, BTC is the underlying asset in the described strategies.
The goal of the Long Call strategy is to earn on the growth of the BTC price above a certain value.
The breakeven sale price when buying a Call = Strike + Option premium.
That is, when you buy a Call option, its break-even point at expiration is the sum of the strike price and the premium paid.
The goal of the Long Put strategy is to earn a fall in the BTC price above a certain value.
When you buy a put option, its break-even point at expiration time will be the strike price minus the premium paid.
Break-even analysis point for buying/selling a Put = Strike + Option premium (Credit).
The goal of the Short Call strategy is to make money on the prediction that the BTC price will be below a certain value at the time of expiration (the date of exercise).
When you sell a Call option, the break-even point will be the difference between the strike price and the premium you receive. Break-even point on a Call option sale = Strike - Option premium (received by you).
The goal of the Short Put strategy is to make money on the prediction that the BTC price will be above a certain value at the time of expiration (the date of exercise). If the outcome is unfavorable, our loss is large but limited (since BTC can fall to nothing less than zero).
When you sell a put option, its breakeven point at expiration will be the strike price minus the premium you receive.
The break-even point analysis for selling a Put = Strike - Option premium (received by you).
Long Put Spread
The Long Put Spread strategy consists of buying a put option with a lower strike and selling a put with a higher strike at the same time. The goal is to make maximum profit on a small increase in the price of the BTC. In this case, both the loss and the profit are limited.
Break-even price when buying Long Put Spread = Long Put Strike - Net cost basis, to enter the position.
Short Put Spread
The Short Put Spread strategy consists of buying a put option with a higher strike and selling a put with a lower strike at the same time. The goal is to make maximum profit on a slight fall in the price of the BTC. In doing so, the trader can limit the possible loss and profit.
Breakeven Price for Short Put Spread = Short Put Strike - Option premium (received by you).
Long Call Spread
The Long Call Spread strategy consists of buying a Call with a lower strike and selling a Call with a higher strike at the same time. The goal is to earn as much as possible on a slight increase in the price of the BTC. The possible loss and profit are limited in this strategy.
The breakeven price for Long Call Spread = Option premium + Long Call Strike.
Short Call Spread
The Short Call Spread strategy consists of buying a Call with a higher strike and sell a Call with a lower strike at the same time. The goal of the strategy is to maximize profit on a slight fall in the price of the BTC. The strategy has limited profit potential, as well as limited losses.
Break-even Price for Short Call Spread = Short Call Strike + Option premium (received by you).
Iron Condor" is an options strategy that allows you to hold a position with a limited level of risk and a high probability of success. The goal of the strategy is to make a profit if the BTC does not change in price significantly, but stays within the set range.
The strategy includes four different contracts — a short call spread strategy out of the money (two call contracts) and a short put spread out of the money (two put contracts). Thus, there are two break-even prices. The breakeven points are above the strike of the short call and below the strike of the short put.
The Iron Butterfly option strategy is a neutral position for the trader with limited risk, but also limited profit potential. The goal is to profit when the price remains fairly stable and options exhibit historical implied volatility.
Like the Iron Condor, the Iron Butterfly consists of four options, consisting of two call options and two put options. It has two breakeven points above and below the strike price of the short option.
Break-Even Prices Before Expiration
In the above examples, it was implied that we always hold a position until expiration. But to calculate the break-even price before expiration, we would need to estimate the P/L under different conditions. In this case, the Black-Scholes option pricing model can help. It determines the theoretical price for European options, under the assumption that if the underlying asset is traded in the market, then the option price on the asset is already implicitly set by the market itself.
What Happens When an Option Hits Breakeven?
When the price of the option passes the break-even point, the trader can simply close the position by selling it. In this case, the profit is equal to the market value of the option minus the original value of the option minus brokerage fees.
However, selling options “in the money” is very risky as their liquidity is remarkably reduced. And closing a large position would require even more effort, as the demand in the order book may decline substantially.
In this case, you can simply execute the options (since American options can be exercised on any day, not just at the time of expiration).
Strike Price vs. Break-Even Price
In general, the break-even price includes the strike price. Here are the brief definitions to illustrate the differences between the two:
- The strike price is the price at which the option holder can buy or sell BTC after the contract is exercised. On the other hand, the breakeven price is the price at which the option buyer receives neither loss nor profit;
- The strike price is fixed and defined in the option contract. The breakeven price is directly related to the value of the premium at the time of buying the option.
Calculating the break-even option price has meaning when trading cryptocurrency options. Without a proper understanding of where the market should go in order for you to break even, it's like shooting in the dark, without an ability to build up more advanced positions with a reasonable risk profile and risk/reward ratio.
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