In this article, we will cover the top three options trading platforms. Moreover, we’ll explain what options are, how they work, and highlight the risks that come with them.
In finance, there is an important instrument called a ‘derivative’. This is financial security whose value is heavily reliant on – or derives from – an underlying asset or group of assets. Put simply, a benchmark. The derivative itself is a contract that pertains to two or more parties. The derivative mainly stems from its price from fluctuations concerning the underlying asset.
Demand for traditional derivative markets in cryptocurrency trading is increasing at a rapid rate. It has taken quite a bit of time to come to fruition, but we are finally at that point. The presence of Bitcoin futures trading has admittedly been around for some time now. However, it wasn’t until this year that a certain number of platforms would open their doors to an interesting part of crypto. And that is cryptocurrency ‘options’.
When you apply Bitcoin to it, this has tremendous benefits for many of the players within the ecosystem. Long-term HODLers and miners can effectively hedge their positions and earn income by way of selling options. Moreover, speculators have the ability to limit downside risks and gain upside exposure for a fraction of the cost. Options of the Bitcoin variety enable traders to bet on the Bitcoin price with high leverage.
What are “options”?
‘Options’ are financial instruments that are derivatives drawing from the value of underlying securities. A good example of such securities are stocks. An options contract offers a special opportunity for the buyer. They can either buy or sell – depending on the type of contract they are holding – the underlying asset. Futures obligate the buyer to purchase an asset or the seller to sell an asset and have a specific future date and price. In the case of options, there is no requirement for the holder to buy or sell the asset if they decide not to.
There are two basic types of options:
- Call options: The holder is able to buy the asset at a stated price within a specific timeframe.
- Put options: The holder is able to sell the asset at a stated price within a specific timeframe.
Each option contract contains a specific expiration date by which the holder needs to exercise its option. The established price on an option goes by the name of ‘strike price’. Purchasing and selling options are typically done with the use of online or retail brokers.
When it comes to buying Bitcoin options, investors pay a premium. They do it for the chance to be able to buy or sell Bitcoin at a set price in the future. This is essentially providing an interesting method of longing or shorting BTC. It gives owners an opportunity to acquire gains in a declining market, plus multiply their profits in a bull market.
As is the case with all options, Bitcoin options holders can exercise their options by the contract expiration date. After this date, the option position will close. Alternatively, should a trader decide to exit the position sooner, they can sell their position at the current market price.
How they work
Options are nothing if not a very versatile financial product. These contracts typically involve a buyer and a seller. It is the responsibility of the buyer to pay an option’s premium for the rights that the contract grants. Each call option has a bullish buyer and a bearish seller, whereas put options have the reverse. Those have a bearish buyer and a bullish seller.
Most of the time, options contracts represent 100 shares of the underlying security. The buyer will have to pay a premium fee for each contract. For example, let’s assume that an option has a premium of 35 cents per contract. In this case, buying one option would cost $35 ($0.35 x 100 = $35). The foundation of the premium partially draws from the abovementioned strike price. Basically, the price for buying or selling the security up until the date of expiration.
An additional factor in regards to the premium price is the expiration date itself. Similar to a carton of milk in the fridge, the expiration date is indicative of when the option contract must be used. The underlying asset is what determines the date at which you need to use the option. In the case of stocks, the expiration date is usually the third Friday of the contract’s month.
Traders and investors alike will buy and sell options for a variety of reasons. Options speculation allows a trader to maintain a grip on a leveraged position in an asset. Specifically, at a lower cost than purchasing shares of the asset. Investors will typically use options as a way to hedge or reduce their portfolio’s risk exposure. Sometimes the option holder is able to generate income whenever they buy call options or become an options writer themselves.
When venturing through the options market, you will come across ‘Greeks’. This is a popular term that describes the different dimensions of commonplace risks in taking an options position. This can either be in a particular option or an entire portfolio of options.
The ‘Greek’ name stems from the fact that the variables use Greek symbols in their identifications. Each risk variable is the outcome of a sketchy assumption or relationship of the option with a separate underlying variable. Traders utilize different Greek values as a means to evaluate options risk, as well as manage option portfolios. The five most common ‘Greeks’ that traders use are Delta, Gamma, Vega, Theta, and Rho. There are numerous others, but these five are the most prominent.
If you want more details about Greeks, read “Trading Greeks.”
Delta (Δ) is representative of the rate of change occurring between two prices. The option’s price and a $1 change in regards to the underlying asset’s price. Put simply, it is the price sensitivity of the option that is comparative to the underlying. Call options and put options have different ranges. The delta of a call option has a range between zero and one. The delta of a put option, meanwhile, has a range between zero and a negative one.
For example, imagine that an investor is longing a call option with a delta of 0.50. In this context, should the underlying stock eventually increase by $1, the option’s price would theoretically increase by 50 cents.
Theta (Θ) represents the rate of change that occurs between the option price and time. In other words, it represents time sensitivity. In some cases, it is recognizable as an option’s time decay. Theta is indicative of the amount an option’s price would dwindle as the time until expiration decreases, all else equal.
For example, let’s assume that an investor is longing an option consisting of theta of -0.50. The option’s price would decrease by 50 cents with each day that passes, all else being equal. Should three trading days pass, then the option’s overall value would theoretically decrease by $1.50.
Gamma (Γ) is representative of the rate of change that occurs between an option’s delta and the underlying asset’s price. This is what is referred to as ‘second-order’ (or second-derivative) price sensitivity. Gamma is largely indicative of the amount that the delta would change with a $1 move in the underlying security.
For example, imagine that an investor is longing one call option on a hypothetical stock. Let’s call it stock ABC. The call option possesses a delta of 0.50 and a gamma of 0.10. Should stock ABC increase (or decrease) by $1, then the call option’s delta would increase (or decrease) by 0.10.
Vega (V) is what represents the rate of change occurring between an option’s value and the underlying asset’s volatility. It is important to note that this volatility is implied and not concrete. In other words, this is the option’s overall sensitivity to unpredictability. Vega is indicative of the amount an option’s price will change with a 1% alteration in supposed volatility.
For example, an option that has a vega of 0.10 suggests that the option’s value will change by 10 cents. That is to say, it will change so long as the implied volatility alters by 1%.
Rho (p) is representative of the rate of change between an option’s value and a 1% change in the interest rate. This measures the overall sensitivity in regards to the interest rate.
For example, let’s assume that a call option possesses a rho of 0.05, as well as a price of $1.25. Suppose that interest rates suddenly rise by 1%. In this case, the value of the call option would consequently increase to $1.30, all else being equal. The opposite of this is true for put options. Rho is arguably the best ‘Greek’ for at-the-money options that each have long times until the date of expiration.
Why are options expensive?
Determining the price of options, which we recognize as the premium, is done by the market. What’s more, it draws its information from the factors of intrinsic and extrinsic value. Intrinsic value is the primary difference between the underlying asset spot price and the strike price. However, it is only in reference to a positive value to the option holder. Whenever an option is not necessarily beneficial to the buyer, it will supposedly have zero intrinsic value. In this sense, only extrinsic value, such as time value, will strike price and volatility.
There are indeed an array of factors and highly complex valuation models that help calculate the value of numerous options. Be that as it may, a handful of the basics are actually quite straightforward. When an option is ‘in-the-money’, it means that holders of the option will receive benefits from exercising their options. When an option becomes this, that means that the option possesses intrinsic value. An in-the-money option is comparatively easier to value because the intrinsic value is set in stone. The extrinsic value is a function of the risk that associates with both time value and volatility.
On the other hand, an out-of-the-money option possesses no intrinsic value. Therefore, its price depends entirely on the factors of extrinsic value. The premium is akin to a fee; one that the writer of the option takes for the risk that comes from selling. It is no surprise that an asset as volatile as Bitcoin – and cryptocurrency as a whole – has expensive premiums.
The best options trading platforms
On the subject of variety, Bitcoin options exchanges get the short end of the stick. As you may recall, there are less platforms for Bitcoin than there are for standard cryptocurrency exchanges. The outcome of this is option 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 that are in the lead. 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 are looking to get exposure to the crypto-centric derivatives space, below are three dominating cryptocurrency options exchanges.
1 – Deribit
Since its launch in 2016, Deribit has made a name for itself. It is an exchange from Amsterdam that focuses on crypto-centric futures and options. To elaborate, the platform gives users the ability to purchase European-style cash-settled cryptocurrency options. These are widely available across both Bitcoin and Ethereum. Put simply, this means that exercising the options only happens once the expiry date matures.
Furthermore, the payment of any ensuing profits that the trader makes at the point of expiry will be in cash. This is in contrast to a less desirable transfer of assets. For those who are showing an interest in the Deribit platform, there is something important to keep in mind. The exchange will charge 0.04% of the value of the underlying contract. Or simply 0.0004 with each BTC/ETH contract.
When it comes to safety, Deribit keeps up to 99% of customer funds in cold storage. Whatever remains is kept purely for the facilitation of withdrawals. What’s more, this options trading platform takes great pride in its rigid internal security controls. Deribit displays great security measures, with zero hacks occurring in its years of operation since its launch.
Last, but definitely not least, there is the underlying infrastructure of Deribit. It is incredibly useful for any instance of high-frequency trading. As a matter of fact, traders have the option of renting a server to cut down on latency times to just ~0.1ms. This is one of the many reasons that Deribit is acquiring a large number of users from a crypto-derivative competitor, BitMEX. This is an exchange that is showing great frustration with its own ongoing latency issues.
Pros & Cons
The pros of using Deribit include:
- A very large range of options contracts that are available
- Verification requirements that are loose and relaxing
- Considerably low trading fees
The cons of using Deribit include:
- There is no support for fiat currency
- A noticeable limit to the amount of customer support options
2 – LedgerX
LedgerX is another popular option trading platform. It is based out of the U.S. and offers Bitcoin spot, options, and futures contracts. The US Commodities Futures Trading Commission (CFTC) is responsible for monitoring the regulated platform. In the past, the initial target of the exchange was primarily the institutional investor space. However, in recent news, LedgerX would get 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.”
On the topic of its options offering, LedgerX offers users with strike ranges from $2,000 up to $50,000. Because of this, its derivative threshold will no doubt appeal to both advocates and skeptics within the cryptocurrency space. Furthermore, there was a recent announcement that the platform would be launching a $100,000 call option. What’s more, it will have a December 2020 expiration date. This is perfect for people who are anticipating the occurrence of digital gold ‘mooning’ in the very near future.
The last thing to note is one that is slightly less positive than what we have been looking at. In a recent reveal, LedgerX boasts about a milestone it is aiming to reach. The exchange says that it was on track to becoming the first cryptocurrency exchange to settle Bitcoin derivative contracts in Bitcoin. This is in contrast to a conventional cash-settlement. Despite this ambition, it would appear that the platform has run into a potential regulatory obstacle.
Pros & Cons
The pros of using LedgerX include:
- A Bitcoin options exchange that is regulated
- Institutional-grade security measures
- Bitcoin binary options that are widely available
The cons of using LedgerX include:
- There is a restriction in the availability
- The KYC requirements are extensive
- Only Bitcoin futures and options are available
3 – Quedex
Quedex is a futures and options exchange whose base of operation is in Gibraltar. It is the owner of a Distributed Ledger Technology (DLT) Provider license, which the Gibraltar Financial Services Commission oversees. The specialty of the platform ties to European Vanilla options. Similar to the case of Deribit, this means that settling the options are done financially. Thus, there is no asset transfer upon the date of expiration.
In addition, the standardization of options trading at Quedex is specifically to futures. This basically means that they are effectively inverse options. Each option possesses a nominal value of $1, so this permits traders to hedge on various different derivative platforms. On the other hand, it is important to note that trading volumes are still, in a way, minimal on Quedex. Although, to be fair, the launch of the platform itself was only in December of 2017.
Nevertheless, when it comes to the options settlement fee, Quedex charges 0.03% for market takers. As for those who are proving the exchange with liquidity, it charges nothing.
Those who decide to trade on this options trading platform will have the ability to purchase contracts across three maturity periods. Most notably, this includes BTC/USD options whose dates of expiration are on a weekly, monthly, or quarterly basis. According to the official website, for advanced options trading, Quedex lets you do the following:
- Visualize the profit potential of your option on the trading dashboard.
- Analyze option price dynamics using payoff charts and risk metrics.
- Submit orders by using implied volatility or Bitcoin quotes.
Pros & Cons
The pros of using Quedex include:
- Derivatives exchange that receives licensing from Gibraltar
- It has great security with PGP-based communications, as well as multi-signature cold storage of funds
- A bankruptcy prevention system that is auction-based
The cons of using Quedex include:
- There is a noticeable lack of liquidity for retail traders
- A KYC verification system that is extremely rigid
- There are no fiat deposits or withdrawals
Cryptocurrency options – whether they be Bitcoin or altcoin – can provide excellent investment opportunities. Be that as it may, they also come with an array of risks and shortcomings. These could potentially make them unsuitable and undesirable for some investors. This is especially the case when using options for speculative purposes. Moreover, if your goal isn’t to use them for reducing or eliminating your risks in another position.
With that in mind, here are some of the most common hazards to watch out for when trading options:
- Risking a significant loss of your capital: Unlike other assets, most Bitcoin options do not offer you a way to cut your losses early. This essentially means that if your Bitcoin option expires out of the money, you will lose your entire initial investment. In other words, the option premium. If you purchase a large number of contracts, it is easy to see this as a considerable loss.
- You need to pay purchase fees to the exchange: For a majority of exchange platforms, charging a per contract fee occurs when purchasing options. This fee is typically a small portion of the underlying asset value. Alternatively, it can be a fixed fee for specific options.
- Limitations with liquidity: Again, the Bitcoin options space is quite small and only has a handful of notable exchange platforms. Because of this, there tend to be liquidity issues. In contrast to standard spot trading exchanges, Bitcoin options exchanges often suffer from low daily trade volume, as well as poor liquidity. This is particularly true when it comes to high-value options. Only certain expiries and strikes possess sufficient liquidity. This poor liquidity can result in significant slippage when opening or closing a position. The option trading will do so at a lower rate due to a delay in matching.
When we’re talking about investments, it is easy to consider Bitcoin options as being a somewhat complex trading tool. As such, it is for the best that investors with more experience utilize them. In spite of this, you might be someone looking to get to grips with Bitcoin options. If you’re this person, then there are two tips that will help keep you safe when navigating this asset class.
Tip #1 – Be sure that you pick a trustworthy Bitcoin options exchange
Such is the case with any investment, it’s crucial to make sure that you are dealing with a reliable platform. In the world of cryptocurrencies, though, not every platform is what it appears to be. Therefore, it would be wise for you to do some research if you find anything suspicious.
Luckily, there are a variety of indicators that are useful in determining whether or not a platform is trustworthy. Some of these include being in operation for a long period of time and being compliant with regulations. Moreover, retaining an excellent track record when it comes to customer satisfaction.
Tip #2 – Do not, under any circumstances, trade with more capital than you can afford to lose
Trading cryptocurrency options can prove to be a very lucrative investment procedure. However, it does come with its fair share of risks and they tend to be rather costly. Especially if you do not take certain precautions. Oftentimes, Bitcoin options are simply a tool that provides an economical method of hedging risk against your spot positions. Due to this, options should usually constitute a small fraction of your portfolio. Moreover, you should avoid large out of the money options where possible.
The bottom line here is that you shouldn’t trade more than you can afford to lose. Be sure to stay safe whenever you are trading options.