The first decade of cryptocurrency’s existence has been an eventful one. Innovation after innovation has emerged in the field of digital currency. Nowadays, it’s not outlandish to envision it becoming a method of payment that reaches the same level as fiat currency. Heck, the fact that there are cryptocurrency options on the market is a big deal in and of itself. It represents amazing diversification and cryptocurrency economics.
Most people would have first heard about cryptocurrency in the later part of 2017. At the time, Bitcoin was on the rise and breaking price records every week. It’s no wonder that a lot of people took note of it. In this sense, cryptocurrency options are clearly another milestone in the development curve. Not just of Bitcoin but also for other cryptocurrencies.
Supporters of crypto would predictably show excitement by the launch of Bitcoin futures and options. However, along with that excitement comes a lack of knowledge. Many are unfamiliar with the basics of this concept. Bitcoin options are a popular method of benefiting a volatile market. How? By strategically hedging a portion of the risk.
What are ‘options’?
Let’s start at the beginning with ‘options’. These are incredibly versatile financial products. At their core, they function as instruments that are derivatives drawing from the value of underlying securities like stocks. As contracts, they give bearers the right – though not the obligation – to either buy or sell an amount of an underlying asset. Specifically, at a predetermined price either at or before the contract reaches its expiration. Purchasing options can be done so in a way that’s similar to most other asset classes with brokerage investment accounts.
Options are powerful instruments because they have the inherent ability to enhance an individual’s portfolio. They do this through additional income and protection, as well as leverage. There is typically an option scenario that’s appropriate for an investor’s goal, but that mostly depends on the situation. A popular example is using options as a competent hedge against a decreasing stock market in order to limit downside losses.
Options are also useful in generating recurring income. Furthermore, they are frequently used for speculative purposes. These instances often include wagering on a stock’s potential direction.
There are two types of options:
- Call options: These allow the holder to purchase the asset at a stated price within a specific period of time.
- Put options: These allow the holder to sell the asset at a stated price within a specific period of time.
Each option contract has its own expiration date by which the holder needs to exercise its option. The stated price on an option is what we call the ‘strike price’. Generally speaking, buying and selling options is through online or retail brokers.
Oftentimes, options contracts are indicative of 100 shares of the underlying security. Moreover, it represents that the buyer is willing to pay a premium fee for each contract. Let’s use an option with a premium of 35 cents per contract as an example. In this case, buying one option would typically cost you $35 ($0.35 x 100 = $35). The premium partially draws from the strike price. This is the price for buying or selling the security up until it reaches its date of expiration.
This leads to another factor pertaining to the premium price, and that is the expiration date. Similar to a carton of milk or a loaf of bread, the expiration date is indicative of the day that you need to use the option by. The job of the underlying asset is to determine what the use-by date is. When it comes to stocks, it will usually be the third Friday of the contract’s month.
There are a variety of reasons as to why traders and investors will buy and sell options. Speculation surrounding options typically allows a trader to hold a leveraged position in an asset at a lower cost. In fact, it’s comparatively lower than purchasing shares of the asset. Investors will often utilize options as a method of hedging or dwindling the risk exposure of their portfolio. There are times when the option holder is able to generate income when they buy call options. Alternatively, when they become an options writer.
Options are also among the most direct ways in which you can invest in oil. For options traders, an option’s daily trading volume and open interest are key numbers to keep an eye on. Doing so will help them make the most knowledgeable investment decisions.
In relation to crypto
At an individual level, options have the capacity to permit the generation of income at the hands of market participants. Moreover, it allows them to make speculative bets, and hedge their positions, particularly in the midst of market volatility.
In an option contract, there is someone who fills the role of a ‘writer’, or seller, of the option. Likewise, there is someone who serves as the buyer. The buyer pays a premium for the options contract that various factors determine. These include moneyness (the asset’s current price vs. the strike price), the expiration time, and implicit volatility. The writer will then take that premium as income.
When we apply this to the context of Bitcoin, it brings huge benefits for many players in the ecosystem. Such figures like long-term HODLers and miners are bot able to effectively hedge their positions. What’s more, they can earn income by way of selling options. Speculators, meanwhile, are able to limit downside risks and garner upside exposure for only a fraction of the cost.
If we observe the market as a whole, we can see that options are indeed a critical element for market health. According to a commonly cited empirical Journal of Finance analysis, an asset’s options listings usually result in:
“…a decrease in the spread and increases in quoted depth, trading volume, trading frequency, and transaction size.”
All in all, results suggest that option listings provide exceptional improvements to the market quality of the underlying stocks. Put simply, Bitcoin options have the inherent ability to benefit the entire ecosystem. Whether it be a specific individual uses them or not, the advantages are plentiful and valuable.
For DIY investors
As any veteran trader will tell you, investing with options is all about one specific thing: customization. Rewards are capable of being incredibly high, but the risk also functions in a similar way. Furthermore, you have an array of choices at your disposal. However, starting the process is not the easiest thing in the world. Not only that but there is plenty of potential for costly blunders.
Generally speaking, options traders are more self-directed investors than anything else. This essentially means that they don’t typically work directly with a financial advisor for managing their options trading portfolio. As a do-it-yourself (DIY) investor, though, you have full control over both your trading decisions and transactions. This, however, does not actually mean that you are working by yourself.
There are a wide variety of communities out there that bring traders together. In these environments, they can discuss different things such as option trading strategies and current market outlook.
A majority of beginners will usually start with stock options. Options that draw from equities – commonly known as ‘stock options’ – are a natural lead for novice traders concerning options. Stock options are listed on exchanges, like the NYSE, but mostly in the form of a quote. It is imperative that traders understand the details of a stock option quote like the cost and expiration date. Especially before they make any kind of move.
If statistics and probability are in your assortment of general interests, then volatility and trading options will likely be, too. In the case of acting as an individual trader, you only need to concern yourself with two forms of volatility. These two forms are ‘historical volatility’ and ‘implied volatility’.
- Historical volatility is indicative of the past. Moreover, it represents how much the stock price was fluctuating on a daily basis over a period of one year.
- Implied volatility draws from what the marketplace is “implying” the volatility of the stock could potentially be in the future. Furthermore, over the complete life of the option contract.
There are several concepts that options traders should be familiar with. However, one of the most important ones is implied volatility. This is mostly because it can assist you in determining the possibility of a stock reaching a specific price by a particular time. It can also help with illustrating just how volatile the market could turn out to be in the future.
How trading them works
First and foremost, it is important to remember that not all crypto options are wholly similar. You can exercise American-style options at any point in their lifetime. European options play out a little differently. You can trade them at any time during their lifetime, but the catch is that you can only exercise them upon expiry. In the trading scene, all information is incredibly vital, which is what leads to the distinction.
The basic question to come out of this is how to purchase these types of options. In the market, there is a common recommendation that traders settle for a reputable platform. On top of that, one that has a solid track record of customer satisfaction. There are a number of options that are available. It ultimately falls on the shoulders of investors to choose the options that are suitable for their investment needs.
A crypto options contract that best fits your investment needs, of course, ideal. As soon as you find one, you are able to purchase either call or put options of your choice. And for a premium fee, too. In the case of Bitcoin options, these will often be priced in BTC. The mode of the settlement will often vary. A majority of exchanges frequently settle in BTC, with BitMEX and OKEx being two notable examples.
Different strategies and impacts
Trading crypto options – Bitcoin especially – will involve watching the price of the option closely. Moreover, keeping an eye on the strike price and maturity. This way, you are able to guarantee that you purchase the right Bitcoin options. At this level, in particular, you will have already had an encounter with many terms. Some of them include the likes of ‘delta’ and the aforementioned ‘implied volatility’. In this sense, let’s assume that you make the choice to buy an options contract. In this case, you will need a decent amount of options for knowledge.
Bitcoin options differentiate from futures in several ways. Most notably, when purchasing a call or put option, you effectively limit your losses to the premium. For that reason, options are comparatively better for hedging. According to Alexey Markov, an options trader from Moscow, this is especially true for a specific group:
“…participants who have large portfolios on their balances.”
This is the main reason as to why they can be complementary to other, riskier investments in any given portfolio. Such precarious investments include futures.
As a whole, Bitcoin options trading strategies are quite complex and consist of a certain level of sophistication. For example, we will use a BTC call option. With this option, you have the option to purchase BTC at the date of expiration at the strike price. You would logically want the price of BTC to rise. Why? Because the more it increases, the more your call option is worth.
The overall volatility of Bitcoin has a substantial impact on its options. More often than not, when volatility experiences an increase, the options price will increase as well.
Different exchange platforms typically have different offers when it comes to options. Obviously, Bitcoin options exchanges are not as plentiful as mainstream spot cryptocurrency exchanges. This is mainly due to the fact that options trading is not as simple a task as spot trading is.
Therefore, there is a strong likelihood of investors looking at certain factors when selecting the right exchange. These factors consist of a wide range of trading options that are available and the trading fees. Moreover, they need to take customer support into account. In a similar vein, they must consider the specific kind of user interface on the exchange dashboard.
In the crypto space, exchange security is clearly a consideration. This is made apparent thanks to how lucrative digital assets are, as well as recent devastating hacks. In 2017, mainstream financial marketplaces such as CME (Chicago Mercantile Exchange) would start to officially offer Bitcoin futures. Since then, the crypto derivatives market would only continue to grow.
The best platforms for trading
On the subject of variety, Bitcoin options exchanges admittedly get the short end of the stick. There are fewer platforms for Bitcoin than there are for standard cryptocurrency exchanges. The outcome of this is options traders have a considerably smaller selection of platforms to choose from.
As a result of these few platforms, there is a very small amount of Bitcoin option trading platforms at the forefront. The number of the most prominent are not enough to fill a top ten list. Though, this limitation may not deter some traders as this means that there is a lot less research to conduct. If you want to gain exposure to the crypto-centric derivatives space, below are three popular cryptocurrency options exchanges.
If you want to learn more about these platforms, read “Top 3 Options Trading Platforms for Crypto.”
1 – Deribit
Ever since its launch in 2016, Deribit would go on to make a name for itself in the crypto space. It is an exchange operating from Amsterdam that puts all its focus on crypto-centric futures and options. To be specific, the platform gives users the ability to purchase European-style cash-settled cryptocurrency options. These kinds of options are widely available across both Bitcoin and Ethereum. This basically means that exercising the options only happens as soon as the expiry date matures.
2 – LedgerX
LedgerX is another popular option trading platform, arguably on the same level as Deribit. Its operations are based out of the U.S. and the platform provides Bitcoin spots, options, and futures contracts. The US Commodities Futures Trading Commission (CFTC) is the group that is responsible for supervising the regulated platform. In previous years, the initial target of the exchange was, for the most part, the institutional investor space. However, in recent news, LedgerX would successfully obtain the approval of the CFTC to offer derivative products to retail clients.
According to the official website, the team consists of exceptional alumni:
“The LedgerX management team comprises Goldman Sachs, MIT, and CFTC alumni, who bring financial expertise, technical talent, and regulatory experience to the firm.”
3 – Quedex
Quedex is a futures and options exchange whose base of operation resides in Gibraltar. It acts as the owner of a Distributed Ledger Technology (DLT) Provider license. This is a license that the Gibraltar Financial Services Commission regularly oversees. The specialty of the platform correlates with European Vanilla options. Similar to the case of Deribit, this means that settling the options are done so financially. Thus, there is no asset transfer upon the expiration date.