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Bitcoin options trading explained
Learn the basics of how Bitcoin options trading works, and compare leading exchanges to trade on.
Options are one of the most complex financial instruments in global markets. While they have existed in traditional financial markets for a long time, they are only in their nascent stage in cryptocurrency markets. They are based on the value of the underlying asset, which, in this case, is Bitcoin.
Bitcoin options are derivatives contracts that allow you to buy or sell Bitcoin at a specified price on a predetermined date or, in some cases, until a predetermined date. When you buy a Bitcoin options contract, it gives you exposure to Bitcoin’s future price volatility. They differ from bitcoin futures in that you do not have an obligation to buy or sell the asset on the expiry date (also known as exercising the option).
The predetermined price at which the options contracts are exercised is known as the strike price. The price you pay for the option is known as the options premium. It is the income that the writer of the option (i.e. the seller) receives for selling the option. The price of option premiums therefore changes over time and depends on a number of factors, such as the time remaining for contract expiration, implied volatility and the underlying asset’s market price.
Trading bitcoin options is a high risk strategy, so it’s a good idea to become familiar with the risks before trading.
Before reading further, familiarise yourself with this glossary of key terms that are essential for understanding how options work.
|Strike price||The price at which the owner of the options is allowed to exercise the option – if they choose to.|
|Exercising||Selling an option in return for the underlying asset (Bitcoin), which can be kept or sold.|
|Premium||The current price of the option.|
|Call||An options contract that will return a profit to the owner if the price of the underlying asset (Bitcoin) goes up. Call options also give the owner the right to buy the underlying asset when the option expires.|
|Put||An options contract that will return a profit to the owner if the price of the underlying asset (Bitcoin) goes down. Put options also give the owner the right to sell the underlying asset when the option expires.|
|Expiration date||The date at which an option must be sold or exercised.|
|Implied volatility||The likelihood that the underlying asset will change in value.|
Types of options
There are two basic styles of options, depending on their exercise date:
- European style: With these options, you can exercise the options contract on the contract expiry date.
- American style: With these options, you can exercise the options contract before the contract expiry date. These are the most popular type of Options in cryptocurrency markets as of 2021.
Bitcoin options are also categorized based on their payment structures and other parameters. These types of options are:
- Vanilla options: These kinds of options usually have no special features and are standardized. These options typically trade on regulated exchanges rather than over-the-counter (OTC) transactions.
- Exotic options: These kinds of options are hybrid in nature and are customizable to your specific needs. They are more complex than vanilla options and usually trade in the OTC markets.
Broadly, Bitcoin options are categorized into two major types:
- Call options: These options give you the right to buy an underlying asset in predetermined conditions. A call option owner profits when the value of the underlying asset is worth more than what they paid for the option (i.e. the market rises). This is similar to going long. For example, if you purchase a Bitcoin option of 1 BTC for US$50,000 and the value BTC rises to US$55,000, you will have made a profit of US$5,000 (minus any fees).
- Put options: These options give you the right to sell an underlying asset in predetermined conditions. A call option owner profits when the market falls, similar to short selling.
How to trade Bitcoin options
- The seller (writer) of the option creates a put or call options contract with an expiry date and strike price.
- The options writer then lists the options on a cryptocurrency exchange that trades Bitcoin options. You can also place a buy order on an exchange which the writer of the option can then fulfill.
- The price of the options contract is called the options premium. The market price of Bitcoin has a critical role to play in the value of the options premium.
You can use Bitcoin options for two main objectives:
- To speculate on the future price of Bitcoin.
- To hedge your digital asset portfolio by purchasing exposure to price movements contrary to your overall portfolio’s position (i.e. go short when most of your assets are long).
It is important to note that this is not an exhaustive list, as your objectives are highly customizable and dependant on your overall portfolio.
Types of premiums
- In The Money (ITM): A call option is ITM when the strike price is less than the market price of Bitcoin. A put option is ITM when the strike price is higher than the market price of Bitcoin.
- Out of The Money (OTM): A call option is OTM when the strike price is more than the market price of Bitcoin. A put option is OTM when the strike price is lower than the market price of Bitcoin.
- At The Money (ATM): Both call and put options are ATM when the strike price is equal to or in the range of the market price of Bitcoin.
There are additional factors that influence the options premium. These factors are known as “the greeks”. These originate from an options pricing model called the Black Scholes Model. This model is used to price European-style options, while American-style options are priced using the Binomial models. Below are the four options greeks, which also measure the risks attached to the options:
- Delta: This measures the sensitivity of the price of the options to the change in the market price of Bitcoin. It measures the change in the price of the option for every $1 change in the price of BTC. For call options, the value of delta ranges between 0 and 1, whereas for put options, the value ranges between -1 and 0. The value of delta continuously changes as the market price of Bitcoin or any underlying asset fluctuates from time to time. It depends on the degree of ITM or OTM that the option is at the moment calculated.
- Gamma: This measures the rate of change of delta for every $1 change in Bitcoin price.
- Vega: Vega is probably the most prominent options greek. It measures the sensitivity of the option’s price to changes in the volatility of Bitcoin’s price. The volatility of Bitcoin’s price impacts ATM options more than it impacts OTM and ITM options. It affects put and call options in a similar fashion, but it has a higher degree of impact on call options than put options.
- Theta: Theta measures the impact of the passage of time on the rate of decline in the option’s value. It is also known as the time decay of the option. All else held constant, it essentially means that the option decreases in value closer to its getting to the expiry date. Theta is usually a negative number which indicates how much the value of your Bitcoin option will decrease each day up to the maturity of the options contract.
How to buy Bitcoin options: Exchanges compared
In the table below is a list of cryptocurrency exchanges and traditional markets that offer Bitcoin options trading. You can compare them on features such as supported currencies, deposit methods and fees.
You can follow the below steps to start trading in Bitcoin options:
- Choose the cryptocurrency derivatives exchange you want to trade Bitcoin options on.
- Ensure to review the commissions, fees and liquidity of the exchange you choose.
- Decide if you want to trade in a call option or put option, depending on your portfolio objectives.
- You can choose from a series of strike price quotes and options durations based on the direction that you think Bitcoin’s price will move in the short term.
What to look for in a Bitcoin options exchange
There are many factors you need to consider before choosing a cryptocurrency exchange for trading Bitcoin options. The major factors are:
- Liquidity: It is essential that the options market you choose to invest in has liquidity enough to match the option writer’s listing and the buyer’s orders.
- Fees: Different crypto exchanges have a variety of fee structures that impact the profit you can make on the options trade. It’s important to review all liquid Bitcoin options markets to check which have the lowest fees and commissions.
- Margin: The options margin acts as the collateral that an options writer needs to deposit before trading in Bitcoin options. This could vary between exchanges.
- Leverage: Leverage allows you to amplify the size of your trades through borrowing funds. Most reliable crypto exchanges offer 100x leverage on Bitcoin options.
- Reputation: The historical reliability and reputation of the exchange should be trustworthy to ensure a smoothly working marketplace.
- Duration and frequency: Different crypto exchanges offer a variety of expiration dates with different strike prices. It’s important to smartly choose the durations and strike prices that match your portfolio objectives.
Pros and cons of trading Bitcoin options
Bitcoin options can be lucrative investment instruments for you to achieve high returns while trading in the digital currency markets. This also makes them an extremely high-risk product, as options will expire worthless if they are Out of The Money (OTM) by the expiration date.
The advantages of trading Bitcoin options are:
- The possibility of significant gains with a comparatively small value at risk
- They can be a great instrument for hedging your Bitcoin portfolio
- They can be cost-efficient due to the leverage opportunities
- Call option holder losses are limited to the value of options premium
- Since options are flexible, they offer many strategic alternatives for your Bitcoin portfolio
- The writer of the options contract could be liable to unlimited losses
- Options can expire worthless if they are Out of The Money (OTM) by the expiration date.
- Bitcoin options are highly complex in nature, which is highly risky for beginner traders just getting into the cryptocurrency markets
- Since only a select number of cryptocurrency exchanges offer Bitcoin options products, they are less liquid
- Options trading often has high commission and trading fees as compared to the futures and spot Bitcoin markets
- Lesser liquidity when compared to the spot and futures markets
- Options aren’t available for all the major cryptocurrencies just yet, so it makes their liquidity lesser than the other types of instrument offering exposure to Bitcoin.
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