Crypto options are derivatives used to buy or sell cryptocurrencies at a predetermined price on a predetermined date. The two parties involved in their trade are issuers who issue these options and traders who buy them. It’s the prerogative of the traders whether they want to exercise their options or not. Regardless, these are used to hedge against risk and speculation in the market.
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What are Crypto Options?
Crypto options have done the cryptocurrency market a lot of good. First, they’ve collectively improved the liquidity of the market. Second, they’ve improved the equilibrium conditions in the market by giving the traders options to exercise arbitrage opportunities. Two types of crypto options are available: call options and put options.
The former is used to buy an option, and the latter is used to sell an option, should a trader choose to exercise that option. These should not be confused with futures because futures are compulsory for the traders to exercise at a predetermined time. On the other hand, options are exercised at the trader’s discretion.
An important point to note is that institutional investors dominate the crypto options market; however, retail traders and smaller investors are now becoming part of this market. Compared to crypto futures and perpetual swaps, crypto options are a low-cost and low-risk solution for trading crypto assets.
A high-level trading process in crypto options involves an option seller writing or creating a call and put option contracts. Each of these contracts has an expiration date, which is when the contract must be settled. Each of these contracts also has a strike price, which is the price at which the option buyer can choose to buy or sell the asset on the expiry date. After this, the option seller lists this contract on a crypto options exchange.
Alternatively, an interested buyer can place an order on the crypto options exchange, and when a seller sees this, he can sell into it.
Europe vs. America
There are two styles of crypto options:
- European: In the European style crypto options, the buyer of a crypto options contract can exercise the option only at the time of the contract expiry. While these options cannot be exercised before expiry, they can be sold or closed out before the expiry date.
- American: In the American style crypto options, the buyer of a crypto options contract can exercise the option at any time before the contract expiry date.
The European options are sold at a discounted rate because the seller has only a one-time option of exercising them. These are usually traded over the counter and are less likely to be found in major cryptocurrency exchanges. On the flip side, American options are not discounted and can be found in the major crypto exchanges.
OTM and ITM
The price of crypto options’ premium is determined by the time remaining in the expiry of the option, the volatility of the option, at the current price of its underlying cryptocurrency. Two important concepts need to be understood concerning the premium pricing of crypto options.
- OTM: Out of the Money for a call option is when the strike price is higher than the current price of the underlying cryptocurrency, and for a put option, it’s when the strike price is lower than the current price of the cryptocurrency.
- ITM: In the Money for a call option is when the strike price is lower than the current price of the underlying cryptocurrency, and for a put option, it’s when the strike price is higher than the current price.
Physically vs. Cash Settled
A crypto option can be settled either physically or through cash. Under the cash-settled type, no actual physical delivery of the underlying cryptocurrency occurs, and security is not required. The settlement takes place in the form of a cash payment.
However, a physically settled crypto option is settled through the delivery of the actual underlying cryptocurrency. A crypto option contract usually states in clear wording what the contract’s deliverable is.
Calls and Puts
As discussed before, call options allow the holder an option to buy a cryptocurrency at a predetermined price either before the expiry of the contract or upon the expiry of the contract depending on the type of option being exercised. On the other hand, put options allow their holder an option to sell a cryptocurrency.
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Can You Trade Options on Crypto Exchanges?
Just like in the stock exchange, many innovative trading products are introduced in the trade of cryptocurrencies; crypto options trading is one such example. Almost all popular cryptocurrency exchanges are currently supporting the trade of crypto options. While the crypto exchanges have operationalized themselves by copying the stock exchanges and their mature best practices, the former are actually performing more efficiently than the latter.
Stock exchanges only operate during business times, such as from 9 to 4 from Monday to Friday. Crypto exchanges, however, remain functional 24/7, allowing people more flexibility to trade and producing a much higher trading volume compared to the stock exchanges. As a matter of fact, many former stock exchange investors have moved to the crypto exchange because their day jobs did not allow them to participate in trading as actively as they wanted.
The main advantage that has reeled in many investors to crypto options is that the holder of the options is not obligated to exercise the settlement if it does not suit him. The risk of buying crypto options is limited to the premium paid by the holder when purchasing the contract.
How to Trade Bitcoin Options
Bitcoin options can be purchased on any crypto exchange that supports crypto options trade. Because of the nonbinding nature of the option, the buyer has to pay a premium to enter an options contract. Currently, Bitcoin options are relatively expensive, but that’s because of this cryptocurrency’s high degree of volatility.
As discussed before, the implied volatility of an asset impacts heavily on its premium. Bitcoin options became legal for trade in the U.S. in October 2017, and acceptance of crypto options has been growing across the country’s financial infrastructure.
Other major cryptocurrencies, such as Ethereum, were quick to follow suit. It’s worth mentioning here that several offshore exchanges also offer binary crypto options in addition to crypto exchanges. Choosing which cryptocurrency exchange to use usually boils down to its credibility and reliability.
Some additional factors to consider can be the purpose of Bitcoin options trading (i.e., as a side income, as the primary income, or as retirement savings), the experience level of the trader (i.e., whether the trader can use advanced reporting features with good effect), the user-friendliness of the exchange platform, and the pricing of the exchange platform. Finally, it’s worth advising that the choice of crypto exchange doesn’t affect the financial outcomes of trading but certainly affects the user’s trading experience.
