Imagine you're a bitcoin (BTC) bull, confident prices will rally, but anticipating a pullback first. Like many people, however, you are not adept at perfectly timing such market entries and feel you may miss the optimal moment to load up on bullish exposure.
For traders facing this common predicament, a structured product known as a lookback call may offer a compelling solution.
A lookback call is an exotic option that gives the holder the right to buy the underlying asset at its lowest observed price during the so-called lookback period.
For instance, instead of trying to pick the exact bottom of the current BTC price pullback from record highs, a trader may consider a three-month lookback with a one-month lookback period.
That means the strike price is set at the lowest value in the first month, and the call can be exercised at that level anytime before the option expires three months after it's issued. So if the BTC price dropped to $100,000 in the initial month before rising to, say, $140,000 within three months, the holder could require the issuer to sell BTC at $100,000.
The option's unique structure ensures the call buyer benefits from securing the perfect dip, maximizing their profit potential by eliminating the need for precise market timing. That's in stark contrast a traditional call option from a centralized exchange, where traders must select a fixed strike price, significantly increasing the risk of a suboptimal entry.
“BTC spot remains near its highs, but implied volatility has collapsed. This combination makes lookback options particularly attractive from a risk-reward perspective,” Pulkit Goyal, head of trading at Orbit Markets, told CoinDesk. “With implied volatility at such low levels, the lookback feature offers perfect entry for limited extra cost.”
Orbit Markets, an OTC desk specializing in options and structured products, suggested a three-month lookback call to its clients, which will set the strike to the lowest bitcoin price over the next four weeks. The suggestion underscores a growing demand for sophisticated risk-management tools and highlights the increasing maturity of the crypto derivatives market.
The benefit of perfect entry comes at a cost, meaning the Orbit's lookback call was priced at 12.75% volatility, somewhat higher than the 0.25% volatility for the regular call option. The issuer of the option is taking on the risk that BTC might drop, forcing them to give you a more favorable strike price. As a buyer, you pay extra that unique benefit.
What if BTC doesn't drop?
It's perfectly possible that BTC immediately rallies from the going market rate of around $115,000 and stays higher over the next four weeks before rallying further to $140,000 by the end of the three months.
In this case, the strike price is fixed at $115,000 after the one-month lookback period ends, giving the call holder the right to buy BTC at $115,000 on expiry.
In other words, even though the prices didn't dip initially, the call buyer still got a good entry, profiting from the subsequent upward move.
Risk profile
The buyer of the lookback call option stands to lose the initial volatility premium paid if BTC crashes to levels below the strike price fixed after one month.
The risk profile, therefore, is similar to that of a standard call option.
