1.5 k
views

A Quick Introduction to Crypto Options

Options trading may appear intimidating initially, but learning its basic concept will simplify the matter. Unlike crypto futures or perpetual swaps, buying crypto options may provide investors with a low-cost and low-risk strategy.

An “option” gives the buyer the right to buy or sell an underlying asset at a specific price. After understanding the general rules that govern this financial niche, we will look into its crypto applications.

Understanding Financial Options

Options are a kind of derivatives, a large category of securities. The price of a derivative follows the quote of another underlying asset.

From a practical point of view, many brokers allow buying and selling financial options on the market. Options are contracts that provide the bearer the right, but not the duty, to purchase or sell the underlying asset. Different options set different predetermined prices and maturity dates.

Why do people buy options? In short, these contracts can help to diversify a person’s portfolio. They do so by increasing their revenue, providing protection, and even leveraging their position.

If you are looking for an example, think of the stock market. A famous example is using options to hedge against a falling stock price to prevent downside losses.

A professional trader can obtain a good income from options trading. Hedge funds frequently use options for speculative objectives, such as betting on a stock’s future direction.

It is worth mentioning that options trading is a complex strategy. Traders dealing with the derivatives market should be very cautious. It is not by chance that most brokers have risk disclaimers when they allow operations on options.

Let us divide the options market into two categories:

  • Put: an option giving the right to sell the underlying asset.
  • Call: conversely, a call is an option allowing traders to buy the underlying asset.

Each contract contains at least two pieces of information:

  • Strike price: the price at which the contract buyer has the right to purchase or sell the underlying asset.
  • Maturity date: the deadline by which traders must choose to use the option right or sell it.

Now that we have clarified the general notions let’s understand how traders use options to earn money.

When Do Options Traders Earn Money?

The financial industry has its way of pricing the cost (or “premium”) of an option. Several mathematical models exist to do so, but we will avoid being excessively technical in this quick guide.

The readers need to know that the price of an option follows the variations of several variables. Among these, we have the price of the underlying asset, its implied volatility, and maturity date.

The general concept is that a trader buying a put does so as downside protection. The opposite is true for call buyers, as one may guess.

The market can find itself in three cases:

  • In the money (ITM): For a call, this means the strike price is lower than the underlying asset’s current price.
  • At the money (ATM): When the strike price of a call or a put is equal to the current price.
  • Out of the money (OTM): When the strike price of a call is greater than the current price of the underlying asset.

Traders may buy a call option with a lower strike price than the underlying asset’s current quote. Intuitively, the cost of this option will be higher compared to those having a greater strike price.

This efficient pricing system excludes the case of “free lunch” in the options market. Options traders tend to anticipate future movements in the underlying market. Consequently, many analysts look at these instruments to obtain information on the market sentiment.

A Crypto Example

We believe it is fundamental to see all the theoretical concepts we have just introduced in a real-life case.

Suppose that a group of traders observed the current BTC price ($44,000) and expected it to increase. Investors may buy 100 call options with a strike price of $46,000 and a 0.002 BTC premium. The maturity of this contract would be March 31st.

At this point, we just need to follow the math. A 0.002 BTC premium at $44,000 implies a value equal to $88. Considering that the group bought 100 call contracts, we obtain $8,800.

Each of these contracts will let traders buy 0.01 (i.e., 1 divided by 100) BTC at $46,000 per token. In other words, investors can purchase 1 BTC at $46,000 by the end of March.

Now, suppose the BTC price hits $55,000 before March 31st. The group of traders can exercise the call option and earn a profit.

How much would they earn? Once again, the math is pretty simple. The difference between the market quote and the strike price is $9,000. If we take away the cost of the option ($8,800), the traders will earn $200.

Let us imagine, however, a catastrophic scenario. What if the BTC price moved to $20,000 by the end of March? In this case, traders would not exercise the option, and they’d lose the premium of $8,800.

This position is safer than that of somebody investing on the spot market. Anyone buying 1 Bitcoin at $44,000 and selling it at $20,000 would end up losing $24,000.

The Risk of Crypto Naked Option Trading

There are many different strategies in the options market. One of the most popular is the so-called “naked” approach. Simply put, it means taking an options position in the underlying asset without opening its opposite one.

Traders who sell a call, for example, are basically shorting the underlying asset unless they also buy it. Selling naked calls (to purchase) and puts (to sell) is a riskier position that can result in significant losses.

Ideally, inexperienced traders should not make use of this strategy. Generally, a better idea is to use options to cover an existing investment.

Conclusions

When you know the fundamental ideas of options, they don’t appear difficult to understand. When utilized effectively, options can give good opportunities on the market. However, the wrong usage of options can have dramatic effects.

Bitcoin live price
Btc
Bitcoin
$30.487
price
1.71843%
price change
BUY NOW

A robust research phase can help us understand how the market will likely move in the future. However, exact predictions do not exist. This is why options are popular instruments among traders who want to minimize losses.

Stay up to date with our latest articles

More posts

How Can Crypto Trading Bots Help You Manage Your Investments?

Bots are computer programs designed to carry out specific activities automatically. They operate with the least amount of human input possible.  Crypto trading bots are automated programs that trade a single coin or a portfolio of cryptocurrencies. They trade on one or more exchanges on behalf of the owner or user.  Cryptocurrency bots can automate trading tactics to increase portfolio profits. Today, we'll take a closer look at this ever-expanding technology.  A Simple Way to See Crypto Trading Bots Artificial…

Viubank: Earn Interest with Highest Crypto APY Through Fixed Deposit Receipt

An innovative new financial service called Viubank offers customers a way to earn interest on their long-term savings accounts. The concept depends on the cooperation with ELG bank, which brings together traditional and crypto-based financial expertise. About ViuBank Viubank is an innovative banking initiative promising simple access to fixed deposits that pay set interest rates. Depending on your preference, you can get daily, weekly, or monthly benefits. Thanks to its Vanuatu banking license, every depositor can open an account on…

WMA: Bitcoin Struggles at $30k as the Market Recovers Slightly

Get the weekly summary of crypto market analysis, news, and forecasts! This Week’s Summary The Crypto Market ends the week at a total market capitalization of $1,286 trillion. Bitcoin manages to withhold the $30k level after a disappointing week. Ethereum lost almost 3% of its value over the past seven days. XRP decreased by nearly 3% this past week. Almost all altcoins are trading in the red, with very few exceptions. The DeFi sector lost over $0.3 billion from the…

Binance CEO CZ Urges Users to Diversify their Investments 

Zhao Changpeng, founder and CEO of the global cryptocurrency exchange platform, Binance, recommends that individuals diversify their investments.  Although Zhao, also known as CZ, warned that he doesn’t necessarily follow his own advice as well. The CEO also assured that Binance users’ funds were "SAFU", as users dread another Terra repeat. "Investment Wise, I'm Not a Good Example" In a Reddit AMA – which means Ask Me Anything – the 44-year-old billionaire briefly discussed a myriad of topics in response…

Cyprus Government Prepares Crypto and Digital Assets Bill

The Government of Cyprus has laid down its own digital assets laws to administer cryptocurrency transactions. It is very likely Cyprus could adopt the new bill before the EU reaches a consensus regarding its own regulatory structure. Kyriacos Kokkinos, an official of the Cyprus government, shared this information in a fintech meeting at Larnaca. Government Supports Crypto Usage Also a member of the European Union, Cyprus has a reputable position in the consortium when it comes to innovation. Just last…

Crypto Now a Popular Investment Option for European Families

More than 50% of European families have some investment in digital currency.   The average European family sees crypto as a viable investment and savings option. This data comes from several recent surveys conducted over different demographic areas. Despite the volatility of the crypto space, as recent events highlight, it has seen a continuous rise in new investors. More people are committing to crypto investments and many of them are taking steps to buy into the growing market.  The flurry…

New MicroStrategy CFO Remains Committed to Bitcoin HODL Plan

MicroStrategy still doesn’t plan to sell its Bitcoin, according to the company’s new Chief Financial Officer Andrew Kang. The recent bear market, which has brought Bitcoin’s value below the company’s average purchase price, hasn’t shaken the organization’s faith. “At this time, we do not have any intention to sell,” said the CFO, after joining the company on May 9th hailing from GreenSky. “There are no scenarios that I’m aware [in which] we would sell.” Shareholders also remain confident and reportedly…

CFTC Chief Backs Regulatory Incentives to Make Bitcoin Proof of Stake

Rostin Behnam – chairman of the Commodities and Futures Trading Commission – is not happy with Bitcoin’s current levels of energy consumption. He believes regulators should establish incentives to push the network towards a proof of stake (POS) consensus model. Not Worth the Energy, says Benham Speaking at POLITICO’s Sustainability Summit, Benham claimed that Bitcoin’s energy consumption doesn’t match its economic output. “That may rebalance over time, but right now it’s clearly skewed,” he said. Most of Bitcoin’s energy consumption…

Terra Collapse Causes G7 to Hasten Crypto-Centric Regulations

Earlier this week, ministers from the world's top economies, the G7, called for greater speed as financial watchdogs introduce comprehensive crypto regulation. This comes shortly after Terra's demise saw several crypto users suffer considerable losses in the space of a week. G7 Contacts FSB to Hurry Things Up The stablecoin failed to maintain its dollar peg and crashed as low as $0.07, with sister token LUNA not far behind. This created a ripple effect as general market anxiety destabilized even…

Andreessen Horowitz Unveils 2022 State of Crypto Report

The Silicon Valley venture capital firm Andreessen Horowitz (a16z) released a report on Tuesday covering the current state of crypto adoption. It highlights Ethereum as the leading blockchain network for developer support but contains very little mention of Bitcoin’s growth. The Potential of Web 3 The VC firm broke boiled down its report into five key takeaways about the current state of crypto. It began by suggesting that the industry is in the middle of its fourth ‘price innovation’ cycle.…