Options Contracts in Crypto Trading
In the previous guide, we were talking about financial risks. This article is for traders who want to find risk mitigation strategies. Particularly, we will talk about options contracts related to cryptocurrencies. It’s a part of a large crypto 101 series, so other parts you can find in the Superorder Medium blog, too.
Note that we will talk about options in crypto so the terms are corresponding. Well, let’s begin without further ado!
Options Basics and Features
An option is a derivative type that allows an owner to buy or sell cryptocurrency at a predefined rate before or right upon the due date. The key thing here is freedom of choice. Options are pretty similar to futures contracts, but unlike futures, they don’t oblige owners to buy/sell assets. It’s more convenient as traders have more flexibility when it comes to market deals and risk mitigation.
Types
First and foremost, let’s look at two main types of options contracts:
- Call. Gives you the right to purchase a target cryptocurrency.
- Put. Gives you the right to sell a target cryptocurrency.
As a rule, investors get call options when they think that the asset’s price will rise. For instance, BTC is around $7,440 now. If you purchase an options contract now and the price hits $8,000 or even more, you will be able to get coins for $7,440 a few months later. Put options work the same way — traders purchase them when they expect the price to decrease. Thus, you will be able to sell BTC for more dollars even if it drops to the bottom.
Another important difference is in the types of market participants. There are buyers who purchase contracts. As a buyer, you have the right to choose: activate contracts or no. However, there are writers — people who create contracts and sell them. Writers get premiums but expose themselves to more risks because they have no choice. If a buyer decides to buy/sell coins, a writer will have to sell/buy them at the predetermined price.
Components
Each options contract has four key elements that define its structure. You want to understand all features to use these derivatives correctly:
- Size. The number of contracts traded in one deal. For instance, if you want to get 2 BTC for $7,000 in a few months, you should purchase 2 call contracts. Bitcoin contracts support SAT so you can invest in less than 1 BTC.
- Expiry date. The date after which an owner of options contracts will not be able to execute them. So-called American options allow activating contracts at any time before the expiry date while European ones trigger at this moment exactly.
- Strike price. This is the rate at which the underlying asset can be sold or purchased. Thus, if you have a contract and want to purchase BTC, you will get coins at the strike price specified in the agreement.
- Premium. It’s just an options contract’s price. A buyer has to pay the premium to a writer to purchase contracts. Overall, this is the only guaranteed spending because you don’t have to activate an unprofitable contract.
If it seems too complicated, we’d suggest not to trade crypto options. Instead, read more about derivatives, try demo accounts, and get familiar with basic trading. Still, options can help a lot in hedging and speculative trading. Let’s look at how they can benefit you.
Options General Use Cases
Generally, options contracts are used for two purposes. Investors consider them as tools for hedging while traders focus on speculative market deals.
As for hedging, the most popular approach is to purchase put options on the cryptocurrency an investor already has in his/her portfolio. If this coin continues rising, an owner simply doesn’t execute contracts. But if rates go down, an investor can trigger the agreement to sell coins at a price close to the initial level. As a result, the guaranteed losses would include only the premium paid to a writer.
The next strategy is speculative trading. Let’s say, if a trader thinks that a certain cryptocurrency will skyrocket, he/she can purchase a call option when the rate is lower. Hence, after the surge, an owner triggers the contract to get coins with a discount. In this case, options contracts would be in the money (ITM). Otherwise, when the price moves down, the contract remains out of the money (OTM).
Advanced Strategies to Fight Volatility
Apart from the aforementioned protective put used for hedging, there are more ways to benefit from options. Here are some examples:
- Collar. Experienced traders use the strategy to protect their assets from price dumps for little to no cost. It provides for buying a put contract and selling a call contract simultaneously. Thus, you get instant premiums from selling contracts and then use these funds to pay for purchases.
- Covered call. This approach is simpler as it’s used to multiply profit quickly. The strategy requires you to sell a call contract on the coin you have. It helps to earn premiums by doing almost nothing. Still, covered calls are risky as you will have to sell your assets at a low rate if a buyer triggers his/her contracts.
- Straddle and strangle. Straddle stands for purchasing call and put contracts on the same coin. Sizes, dates, and strike rates are the same, too. With such a duo, a trader can benefit from both market movements, either up or down. Strangle features lower premiums thanks to higher (for calls) and lower (for puts) strike prices.
Summing Up
Options contracts are convenient derivatives as they give traders the required market versatility. They help in long-term hedging and in high-frequency trading, as well. However, the options are less popular on crypto markets than on traditional stocks-and-bonds exchanges due to higher volatility. They come with more risks for writers and higher expenses for buyers.
Anyway, these contracts are viable if you want to try more advanced market strategies. Just remember about risks! More about crypto, trading, and coins, you can find in our Telegram chat, Facebook page, and Twitter. Feel free to clap and share the article if you think it’s useful. Cheers!
