Bitcoin Options Explained
This guide to cryptocurrency options can shed some light on the mechanics of these tools and how they are used in the industry. For major institutions, miners and other corporates involved in the space, options are a powerful tool for managing risk and volatility. They are also used by speculators to profit off the volatility of cryptocurrencies.
What is an options contract?
Options are a form of financial contract known as a derivative. In a nutshell, they are contracts between two or more parties based on an underlying financial asset. The underlying asset can be a stock, index, bond, currency, or commodity.
Historically, the first options were used in ancient Greece to speculate on the olive harvest. In 1973, the CBEO was launched which was the start of the modern standardization of exchange traded call options. Options are a category of derivatives, all options are derivatives but not all derivatives are options.
What is a crypto or bitcoin option?
Crypto options are contracts between two or more parties based on an underlying financial asset, which in this case is crypto or bitcoin.
This is a kind of derivative that gives the buyer the right, but not the obligation, to buy or sell an asset at a certain price in the future. Traders will pay a premium for the right to buy or sell the asset at a specific strike price. The premium is the only potential loss for a trader buying a call option. The size of the premium will be decided by the exchange or trading counterparty, they will take into account the current price of the underlying asset, the market’s volatility, the strike price, and the time to expiry.
There are two kinds of options contracts. The first one is called a call option and this gives the holder the right to buy an underlying asset at a certain date. The second is called a put option and the holders of this are given the right to sell the underlying asset. Call options are seen as a bullish view on the market, while Put options have a bearish view.
How do bitcoin options work?
To understand how bitcoin options work, we must first familiarize ourselves with these terms:
- Option Type : Either a call (right to buy) or a put (the right to sell).
- Underlying asset : The asset being traded, in this case Bitcoin.
- Strike Price : The price of the underlying at which the buyer has the option to buy or sell.
- Option Premium : Price to pay for the contract
- Expiry Date : The date at which the option is exercised.
For an option to be in the money, it must exceed the strike price. If an option is not in the money, it will expire worthless.
What are the styles of crypto options?
Options contracts can also be classified according to different expiration styles. With American options, the holder of the contract can buy or sell anytime before the expiry date but European options only allow holders to buy or sell on the expiry date itself. The style of the expiration will affect the price of the option.
What are the benefits of buying crypto options?
Here are some of the benefits of crypto, such as bitcoin options:
- Limited downside (premium is maximum loss)
- Good fit for strategic trading and risk management
- For speculators, is a way to have large profits with small cost
- You do not have to hold the underlying asset, this is especially helpful for traditional investors new to crypto
- Cannot be liquidated like futures contracts
- High flexibility
What are the risks of crypto options?
In comparison to buyers, sellers of options can incur greater losses than the price of the contract. Option sellers are exposed to similar risks associated with futures contracts, where losses can be substantial. There are also time constraints to your investment thesis, you don’t just have to be right, you have to be right at the right time. Your options contract will lose value everyday it moves towards its expiry if the price fails to move. It is also not possible to have a long-term investment plan like you might have with buying in the spot market and holding the asset for many years. There is a higher learning curve for traditional spot traders and investors, these products are not recommended for beginners.
Why are investors using options?
Options and futures are powerful tools for managing risk and volatility. The main two reasons why investors use cryptocurrency derivatives is to protect themselves against market risks, as well as speculating on the market’s volatility. For example, GSR partners with bitcoin mining firms to hedge their future production, while retail traders speculate on bitcoin’s price using contracts on reputable exchanges like Deribit.
Here are other reasons why investors use crypto like bitcoin options:
- Small movements in the underlying value can result in healthy profit
- The value of the derivative can be linked to a specific condition or event which can protect the interest of both buyers and sellers. For example, the underlying asset reaching a specific price level
- Traders can use options contracts to speculate on Bitcoin without having to store the asset
- The flexibility of options allows them to play a role in risk management strategies, crypto native companies use them to hedge against their risks. Options make futures risks tradable
Bitcoin options frequently asked questions (FAQs)
Here are the most asked questions of investors about bitcoin options:
Can I buy options on Bitcoin?
Yes, you can! And you have to decide whether you’re buying a call or put option. To trade crypto options, you can register on a trusted options trading platform where you deposit funds, these products are not recommended for first time traders.
Where can I buy bitcoin options?
For retail traders you can trade options at exchanges such as Deribit and Binance.
How much do you need to start trading bitcoin options?
If you want to start trading options, do you need $100? $500? The answer is it depends on the platform you are using, and the investment size you are comfortable with. In more recent times, apps like Robinhood have powered a new type of options trader who invest small amounts in traditional markets, hoping for large returns.
What are the crypto options prices?
As mentioned previously, the price of an option is dependent on the conditions of the options market. The price is usually based on many factors such as the spot price, strike price, volatility and time to expiration.
Does GSR trade bitcoin options?
Yes, but not with everyone. In the digital asset ecosystem derivatives volume has grown rapidly in the last 12 months as institutions and others look for alternative means of exposure to cryptocurrency assets.
However, exchange-listed options can be relatively limited in their scope for institutions. With markets maturing, a need has emerged for contracts with greater flexibility. GSR has been successful in attracting market participants looking for custom products. This includes Bitcoin and Ethereum miners that have specific hedging needs which are not well served by listed derivatives due to the fluctuating dynamics between electricity rates, underlying asset prices and network hash rate. Our custom products trading activity with the mining community alone surpassed an annualized run rate of $250M by the end of 2020. For multiple periods throughout the year, GSR’s BTC options’ total daily open interest surpassed CME-listed options.
The company also facilitated multiple options markets for altcoins, as a growing number of projects and investors require bespoke products to manage their unique risks and exposures. GSR executed over $1 billion worth of such custom contracts in 2020.
Learn more about custom options for crypto natives here: our services >
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