Beyond Bitcoin futures, cryptocurrency options contracts have become a popular product pursued by both retail and institutional investors. The greatest advantage of options is their defined, limited risk for the buyer, coupled with theoretically unlimited profit potential.
Data shows that cryptocurrency options trading volume surged from $8 billion in the first quarter of 2020 to $45 billion in the fourth quarter, achieving a total annual volume of $77.2 billion for 2020.
Consequently, digital asset options play a significant role in the crypto ecosystem, offering a variety of use cases for traders and investors.
Understanding Cryptocurrency Options
An options contract is a type of derivative that represents an agreement between two parties to facilitate a potential transaction of an underlying asset at a predetermined price—known as the strike price—on or before the expiration date.
While derivatives can cover various instruments like stocks, bonds, commodities, currencies, and market indices, the underlying asset for a crypto option is a digital asset like Bitcoin (BTC) or Ethereum (ETH).
Digital asset options are very similar to futures contracts, as both represent a two-party agreement based on a cryptocurrency. However, unlike futures, where the buyer and seller are obligated to fulfill the contract, the holder of an options contract is not required to execute the trade at expiration.
The buyer (holder) purchases the option from the seller (writer) for a premium. Even if the buyer chooses not to exercise their right, they still forfeit the premium paid.
The price of this premium depends on several factors, including the asset's value, the strike price, market volatility, and the time remaining until expiration. Higher volatility typically increases the premium, while shorter time frames are generally cheaper due to the lower probability of a favorable price move.
Based on products offered by brokers and crypto exchanges, options are categorized into two primary styles: American and European. American options allow the holder to exercise their right at any point before expiration, while European options can only be exercised precisely at the expiration date.
Like other derivatives, crypto options traders can use leverage, which amplifies both potential returns and risks. Besides increasing profit potential, traders can also use crypto options to stabilize against price volatility, hedge market risk, and take short positions on digital assets.
Core Principles of Crypto Options Trading
You can trade cryptocurrency options in two fundamental forms: calls and puts.
A call option gives the buyer the right to buy the digital asset at the predetermined strike price. A put option gives the holder the right to sell the cryptocurrency at the given strike price.
Let's explore four common scenarios to understand the basic mechanics.
Buying a Call Option
Buying a call option signals a bullish sentiment, as the holder anticipates the value of the underlying digital asset will rise in the near future.
By purchasing a call contract, the buyer protects themselves from high volatility. Instead of buying the asset outright on the spot market, the trader uses the call to hedge their position. The only risk faced is the premium paid for the contract.
If, at expiration, the asset's value is significantly above the strike price, the holder can exercise their right to buy at a discount and profit. Conversely, if the cryptocurrency's value is below the strike price, the holder can simply let the option expire worthless, limiting their loss to the premium paid.
Buying a Put Option
While buying a call is a bullish signal, purchasing a put option indicates the holder believes the underlying asset's price will decrease.
However, unlike shorting a cryptocurrency, the put option holder is protected from sudden price increases in the asset's value. The put holder can choose not to exercise the contract at expiration, losing only the premium.
The buyer will profit when the spot price is below the strike price by an amount greater than the premium paid for the contract.
Selling a Put Option
Interestingly, a trader who is bullish can also profit by selling a put option.
If the cryptocurrency's spot value remains above the strike price, the buyer of the put will likely not exercise the trade, so the seller profits from the collected premium.
While the premium offers profit potential, the seller, unlike the buyer, is obligated to buy the asset if the holder decides to exercise their right. Therefore, the seller's potential losses can be significant, though they still keep the premium.
Selling a Call Option
Similar to buying a put, selling a call option also provides a trader with an opportunity to profit from bearish price movements.
As with selling a put, the seller generates profit from the premium if the buyer does not exercise their right. The call seller profits only if the asset's spot value stays below the strike price. If the price rises above it, they are obligated to sell the asset at the lower strike price, incurring a loss.
Top 3 Popular Crypto Options Trading Strategies
One of the key advantages of crypto options is their high flexibility, allowing traders to utilize a wide range of strategies. Here are three of the most popular ones:
Protective Put:
A trader uses this strategy when they already hold the underlying asset. To hedge against potential downward price moves, you purchase a put option with a strike price at or near the asset's current value. If the cryptocurrency's price falls, you can exercise your right to sell at the strike price, covering most of your losses. If the asset's value increases, you let the put expire and only lose the premium paid.
Covered Call:
This involves a trader selling a call option while simultaneously holding the underlying digital asset. This allows you to generate extra income from the premium if the price stays flat or decreases and the call is not exercised. The owned asset covers the potential obligation of the sold call, which is why the strategy is called "covered."
Straddle:
A trader simultaneously buys a call and a put option with the same strike price and expiration date. This might seem counterintuitive, as you are betting on both a price increase and decrease. However, in times of high expected volatility, a straddle can be profitable if the price moves significantly in either direction, with the profit from one side exceeding the total cost of both premiums.
How Does Options Trading Impact Crypto Market Trends?
Cryptocurrency options trading rarely has a direct, immediate impact on the spot price of the related crypto asset. However, the concentration of large volumes of capital in out-of-the-money (OTM) options nearing expiration can suddenly increase market volatility and influence the underlying asset's price.
OTM options are calls with a strike price above the current spot price and puts with a strike price below it. If the overall market sentiment is bullish, call options will be more prevalent.
In a bullish scenario, market makers—who provide liquidity to exchanges—may hedge the OTM call options they sold by buying the underlying asset before expiration. When a large number of OTM options expire within a short period, this hedging activity can create significant volatility and further drive up the cryptocurrency's price.
While crypto options are growing in popularity, the market is still in its early stages, especially when compared to the trading volume of digital asset futures contracts. Despite recording $77.2 billion in volume in 2020, futures volume was $12.31 trillion during the same period.
Crypto options diversify the digital asset market, providing investors with multiple use cases like hedging risk and amplifying potential gains through leveraged trading strategies. For those looking to explore these advanced instruments, it's crucial to use a robust platform. 👉 Explore advanced trading strategies on a leading exchange
Frequently Asked Questions
What is the main difference between futures and options?
The key difference is obligation versus right. Futures contracts obligate both parties to buy or sell the asset at expiration. Options give the buyer the right, but not the obligation, to execute the trade, while the seller has the obligation if the buyer exercises.
Can I lose more than I invest when buying options?
No. When you buy a call or put option, the maximum loss you can incur is limited to the premium you paid for the contract itself. Your risk is defined and capped upfront.
What does 'out-of-the-money' (OTM) mean?
An option is OTM if exercising it currently would not be profitable. A call is OTM if the market price is below the strike price. A put is OTM if the market price is above the strike price. These options have no intrinsic value, only time value.
Why would someone sell an option?
Sellers, or writers, receive a premium upfront for taking on the obligation. They profit if the option expires worthless (OTM) and they keep the entire premium. They often use strategies to hedge the risk of being assigned.
Are crypto options available on all exchanges?
No, not all cryptocurrency exchanges offer options trading. It is primarily found on larger, established platforms that provide advanced derivative products alongside spot trading.
How does volatility affect my options trade?
High volatility generally increases the price (premium) of options because the probability of a large price move is higher. This is beneficial for options buyers hoping for a big swing but can be riskier for sellers. Low volatility typically leads to cheaper premiums.