Bitcoin Options Trading Explained In 5 Minutes

Published in

BasedMoney

5 min readJul 2, 2020

In this article, I will attempt to explain the basics of options trading. There are multiple articles about this topic, however, they often use complex examples further confusing beginners.

Disclaimer: This article is simply for educational purposes. I’m not a financial expert, and you should always trade at your own risk.

So what is an option?

An option is a contract that gives the holder the right to buy or sell an asset at a predetermined date and price.

Basically, trading options is like making a bet on the future price of an asset.

There are 2 types of Options:

1. Call Option (Bullish)

Gives the holder the right to buy a specified amount of an asset at a predetermined price on a specific date.

2. Put Option (Bearish)

Gives the holder the right to sell a specified amount of an asset at a predetermined price on a specific date.

Example:

Bitcoin is currently trading at $8000. You’re bullish on Bitcoin and you want to make a bet that the price will rise above $10,000 before the end of the month. So you purchase a call option: at a cost or premium of $100; at a strike price of $10,000; with the option set to expire at the end of the month (30 days).

Premium: $100
Strike price: $10,000
Days until expiration: 30 days or 1 month

You lose if:

Bitcoin’s market price is less than $10,000 at the end of 30 days. The option will become worthless.

You win if:

The price of bitcoin soars past $10,000 before or at the end of the 30 days. In this scenario, if the price of Bitcoin soars to $12,000. Your call option has gained value because your option’s strike price of $10,000, is now less than the spot price of Bitcoin ($12,000). Your call option is now worth $2,000, a gain of $1900 from the initial $100 price you paid. You also now have the right to purchase Bitcoin, which is trading at $12,000 when the option expires, for $10,000 ($2,000 cheaper than the market price!). However, you aren’t obligated to exercise your option, you can always close your position by selling your option before the expiration date.

In practice, exchanges like Deribit automatically settle options at expiration.

How are Options prices calculated?

The main factors affecting an option’s price are the underlying asset’s price, the strike price, the time premium, and the implied volatility.

1. Underlying Asset’s Price

As the underlying asset’s price increases, the price of a call option increases. As the underlying asset’s price decreases, the price of a put option increases.

2. Strike Price

Each option has a target price called a strike price. The strike price determines if an option can be exercised or not. The price difference between the underlying asset and the strike price help determine the option’s value.

If a put option’s strike price is greater than the current market price of Bitcoin, then that put option is considered in the money (ITM) giving the holder the right to sell Bitcoin at the strike price upon expiration. Otherwise, the option is considered out of the money (OTM).

For calls, it’s the opposite, a call option with a strike price less than the current market price of Bitcoin is considered in the money, while call options with strike prices greater than the market price of Bitcoin are considered out of the money.

Traders can still profit from purchasing out of the money options. They could have bought a cheaper far out of the money option, but now that option is moving closer to being in the money (ITM). That option could end up being worth more than the trader paid for the option, even though it is currently out of the money.

The image above shows the option chain on Deribit and at the time, Bitcoin was trading at $9,245.62.

The highlighted green section shows call options that are in the money since their strike price is less than the current market price and therefore, has more value than out of the money options.

The left side shows all the put options with the highlighted red section representing put options that are in the money since they have a strike price greater than the current market price of Bitcoin.

3. Expiration Date

The expiration date represents the day that the option contracts can be exercised.

As mentioned before, when an option expires in the money, its owners can choose to exercise the option or close the position to realize their profit. If an option is out of the money on the day of expiration, it expires worthless.

4. Implied Volatility (IV)

Implied Volatility is the expected magnitude of the future price change as implied by the option’s prices.

Higher IV represents larger expected price movements
Lower IV represents smaller expected price movements
IV increases as option prices increase and decrease as option prices decrease.

Each option contract has different IV values due to the strike price and the number of days until expiration.

We can use the following formula below to calculate the expected price range of an asset’s price for any time frame:

Market Price x Implied Volatility x √(Days Till Exp./365)

For example, if Bitcoin is currently trading $10,000 with an implied volatility of 20%.

30 day expected range = $10,000 x 20% x √(30/365) = ± $573.38
60 day expected range = $10,000 x 20% x √(60/365) = ± $810.88
60 day expected range = $10,000 x 20% x √(120/365) = ± $1261.44

IV goes up when more traders are buying/selling options, and it goes down back to the regular value after some time, also known as “IV Crush”.

A general rule of thumb is you should buy options when IV is low, and sell options when IV is high.

So why trade options?

Options can provide a more cost-efficient way to gain market exposure without owning the underlying asset. Since you’re simply purchasing the right to buy or sell, you don’t need to hold the underlying asset and your max loss is capped at the premium you paid for owning the option. You can also sell or ‘short’ options but that’s out of the scope of this article and should only be done by advanced traders.

Ready to trade options?

Looking for an edge?

CoinOptionsTrack is a simple, and easy-to-use options analytics tool for new and advanced traders.

Real-time + historical options price data from Deribit
Beautifully displayed analytics
Open Interest across expirations and strikes
Max-pain price and more!