What are Options and how can you utilize them in Crypto?

Basics

Options are a type of derivative contract that offer their holders the choice to purchase or sell a security at a specified price at a future date, but not the obligation to do so. The sellers of options charge a sum known as a premium for such a right. Option holders will let the option expire worthless and decline to exercise this right if market prices are unfavorable for them, limiting potential losses to the option premium. In contrast, if the market shifts in a way that increases the value of the underlying asset, the option can get exercised.

Call and put contracts are the two main types of options. When purchasing a call option, the contract’s buyer acquires the right to purchase the underlying asset at a later time for a fixed sum known as the exercise price or strike price. A put option gives the buyer the ability to sell the underlying asset at a future date and price.

Options contracts come in two different styles: American-style and European-style options. American-style options can be exercised at any moment up to and including the date of expiration. European type options can only be exercised on the day they expire. When it comes to the “classical” options markets, American-style options are the most common ones. I do not exactly know if that is the same in Cryptocurrency Land, but Binance (non-US) offers European-style options.

Options can be either “in-the-money” or “out-of-the-money”. In-the-money means that when buying a call option for example the underlying asset has, at the time of buying, a higher price than the strike price. Out-of-the-money means the opposite, the underlying asset has a lower price than the selected strike price of the option (for calls). The terms are switched for puts.

Not as the underlying asset, for example Bitcoin, the option is not only dependent on price, but also on time. Options always have an expiration date, which means if the option is out-of-the-money the premium value will decrease the closer the expiration date comes.

Buying Calls (Long Calls)

For individuals wishing to place a directional bet on the market, trading options has several benefits. You can purchase a call option with less capital than the underlying asset if you believe the value of the asset will increase. In contrast, your losses are capped to the premium paid for the options and nothing more if the price instead declines.

An example:

Options are essentially leveraged instruments in that they allow traders to amplify the potential upside benefit by using smaller amounts than would otherwise be required if trading the underlying asset itself. So you could buy one $17,000 BTC call option today, that for e.g. expires on the 24th of December. You pay a $200 premium, the BTC price rises to $20,000 until the 24th of December. You will be able to either exercise the option and still pay $17,000 for 1 BTC and possibly sell it for a $3000 profit — $200 premium, which makes a net profit of $2800. Or you could sell the option with a now increased premium and make a profit with it.

Buying Puts (Long Puts)

A put option gives the holder the option to sell the underlying asset at a predetermined price in place of the call option’s right to buy the underlying asset at a predetermined price before the contract expires.

When compared to a call option, a put option functions exactly the opposite way, increasing in value when the price of the underlying falls. The risk associated with a short position is endless because there is theoretically no upper bound on how high a price might increase, even if short-selling also enables a trader to profit from declining prices. If the underlying value exceeds the strike price of a put option, the option will simply expire worthless.

Where to trade cryptocurrency options?

The easiest places to trade crypto options would be central exchanges. You can trade crypto options on Binance or Bybit for example. The CEX’s have limited pairs for option trading though (in my region). On Binance you can trade Bitcoin, Ethereum and BNB options. On Bybit you can trade Bitcoin, Ethereum and Solana options.

Crypto options are still quite rare and will possibly increase in the future. Options are a good asset to hedge, but that is a complete topic in itself, which I will probably cover at some point in the future.

I hope this helps you to understand options a bit. If you have any questions I will try to answer them as best as possible. If I made any mistake explaining options, feel free to write it in the comments!

Have a good day!

Niklas

This is not financial advice!