Can you get insurance on a leveraged trade

Question

The number one rule in trading is to set a stop loss.

However, unless you are in the top minority of traders, there's a good chance you'll set a stop loss that gets hit even on a winning trade.

I'm curious if there is a viable method to get sort of "insurance" on your position, so that it doesn't get liquidated for x amount of time.

For example if i leverage on Bitcoin going up in the next few months, i don't want to risk getting liquidated in the short term because of Elon Musk's tweets. Therefore I could buy insurance for 3 months that might cost perhaps 10% or 20% of my position.

Do methods to achieve insurance like this exist?

I was considering one method could be to buy an out-of-money put where the strike price is just barely above your liquidation price, with an expiry in 3 months time.

However, I doubt many exchanges will prevent liquidation on a leveraged position if you have a put option to prevent it, especially if your options are in the futures market and your position is in the spot market.

Options are also problematic because they are generally done in the futures market where there are high funding fees in order to force a net zero profit (for every one person that wins a trade, one person has to lose).

Are there any alternatives to achieve insurance or improvements on my ideas? Even if exchanges don't exist for a particular method, it would be interesting to see ideas from a purely economical/mathematical viewpoint as well, that could theoretically exist in the future.

Answer 1

There are a few things to consider here

1. Insurance: Although a popular speculative tool, options and most other derivatives are essentially insurance products. So in very simple terms, options are the answer to the question you asked. Are they a good risk-adjusted way to achieve your trading POV? What is the right strike/vol premium level to offset the risk you're trying to offset? That's a separate question.
2. Leverage: How much leverage are we talking about? The higher the leverage, the likelier you'll be liquidated. For example, if you're trading with 100:1 leverage (which sounds batshit crazy to me), then your liquidation price will be extremely close to your entry price, and the options you'll need will be more at-the-money than out of.
3. Position Sizing: You could protect yourself from being liquidated by sizing your position correctly relative to your capital so you have some cash or other acceptable collateral in your account. If you go all or nothing on your trade, and the brokerage has little to no room for error, then your account will be prone to liquidation from even the most temporary price dips/spikes (depending on the direction of your leveraged trade)
4. Risk/Reward: I understand that markets are crazy these days, but how much of an increase are you betting on that justifies a 10-20% capital outlay on out of the money insurance? Over a 3 month period, you'll be losing an average of approx 0.8-1.6% of your capital every week in decay alone. Also, such an "insurance" structure actually worsens your worst case scenario (cost of leverage + option premium + price drop), and increases the threshold for your best case. Personally, I would have to be really confident in my expectation of an extremely high rally (+50%) to justify that.

Maybe the right question isn't how to protect being stopped out of a leveraged trade, but what the right trade is to express your point of view. As someone else has pointed out, maybe just buy call options? Or buy a call spread or strangle so that when Elon Musk tweets, you have several options of what to do with the short leg of the spread (put you bought or call you sold).

Since you have these questions about holding onto a leveraged trade, i'm going to guess that selling options might not be a feasible option for you, so you will be buying decay (consistent loss of capital over time - all things being equal) which could be compared to drinking arsenic over a long period of time...no single day/symptom is bad enough that you want to rush to the doctor...but soon enough you're walking to the light.