What are bitcoin options?
Bitcoin options present a new and exciting way to take a position on the famous cryptocurrency. Read our one-page guide to learn about what bitcoin options are and how they work.
According to data from Blockchain, the daily volume of bitcoin (BTC) transactions has risen by more than 420% during the last five years – from 59,344 in January 2015 to 309,070 in January 2020.1 And as the demand for the cryptocurrency grows, so too does the number of ways to trade it. The latest addition for traders to sink their teeth into are bitcoin options.
What are bitcoin options?
Bitcoin options2 are a form of financial derivative that gives you the right, but not the obligation, to buy or sell bitcoin at a specific price – known as the strike price – at a certain date of expiry. You pay a premium – usually cheaper than buying cryptocurrency outright – in order to buy an option.
Unlike buying bitcoin via a cryptocurrency exchange, options enable you to take a speculative position on the future direction of a market price – whether this up or down.
Bitcoin options have been trading on cryptocurrency exchanges for a while, but were not regulated. Now, bitcoin options are being slowly introduced by some regulated institutions, although not every provider will have an offering, so it’s important to check where you can trade bitcoin options.
Bitcoin options enable you to trade on cryptocurrency volatility without ever having to take ownership of the underlying asset. As bitcoin is a notoriously volatile market – famous for its 1900% rally in 2017 followed by an 82% decline throughout 2018 – this product has been in high demand.
Essentials of bitcoin options trading
The terminology used in options trading is the same regardless of the specific market you are trading, but it is still important to familiarise yourself with the key concepts before you trade bitcoin options.
Holding and writing options
In an options contract, there are two parties: the ‘holder’ or buyer and the ‘writer’ or seller. This applies to both put and call options – which means that you can take a long or short position with either type of option.
When you hold an option, you’ll pay a premium to purchase the right to buy or sell bitcoin. But when you write an option, you are selling your right to decide to the buyer – if the options contract is exercised by the holder, you would have to uphold your end of the contract. For taking on the risk of doing so, you would receive a premium.
Bitcoin call options
Buying a bitcoin call option gives you the right, but not the obligation, to purchase a specific amount of bitcoin at a set price (the strike price) at or before the expiration date. You’d buy a call option if you believe the market price would increase.
If your prediction was correct, and the market price increased above the bitcoin option’s strike, you’d be able to buy bitcoin at the prespecified price. How far the underlying bitcoin price rose past the strike price, would influence how much profit you’d make from the trade.
If your prediction was incorrect, and the price of bitcoin declined instead, you could let the options contract expire worthless, and only lose the premium you paid to open the trade.
Had you decided to write a call bitcoin options contract instead, you’d be taking on the obligation to sell a specified number of bitcoin, at the strike price, at the time of expiry. You would do so if you believed the underlying market price would fall or see little volatility.
However, if the market price did increase and the buyer executed the put option, you’d have to sell your bitcoin and would limit the profit you could make from your existing holding.
Bitcoin put options
Buying a bitcoin put option gives you the right, but not the obligation, to sell a specific amount of bitcoin at a set price, at or before the expiration date. You’d buy a bitcoin put option if you expected the market to decline in price.
If your prediction was correct, and the bitcoin price declined below your chosen strike price, you could sell your bitcoin holding at higher price than the new market value. How far the underlying bitcoin price decreased below the strike price, would influence how much profit you’d make from the trade.
If your prediction was incorrect, and the bitcoin price increased instead, you could let the options contract expire and you’d only lose the premium.
Alternatively, if you decided to write a put bitcoin option, you’d be taking on the obligation to buy the bitcoin at a specific price, on a specific date. You’d do so if you believed the underlying price would rise, and were comfortable taking ownership of the asset in question at a future date.
However, if the market price did decline and the buyer executed the put option, you’d have to buy bitcoin at a potentially higher cost.
The Greeks are terms used to describe the factors that influence an option’s price – they determine whether you will pay more to open an options contract (or receive more in the case of writing options).
- Delta measures how sensitive an option’s price is to a one point move in the underlying bitcoin price
- Gamma measures of how much the bitcoin option’s delta moves for every one point move in the underlying bitcoin market
- Theta measures how much an option’s price decays over time. A bitcoin option with a high theta will be closer to the expiration date
- Vega measures the option’s sensitivity to implied volatility in the underlying bitcoin market, and how much the option’s premium will change for every 1% change in volatility. As bitcoin is such a volatile asset class, vega has a significant impact on options pricing
- Rho indicates how sensitive an option’s price is to changes in interest rates
If you’re looking for a way to trade bitcoin, but aren’t familiar with options trading, you could explore CFD trading – which enables you to take a position on bitcoin’s price without having to own the underlying cryptocurrency.
Bitcoin options strategies
There are different bitcoin options strategies that can be used depending on your motivation behind trading – whether it is to speculate on bitcoin’s price, or hedge against any risk to an existing BTC holding.
For speculative traders, there are a range of options strategies that can be used to take advantage of options volatility. For example, a straddle options strategy involves simultaneously buying and selling an equal number of bitcoin puts and calls with the same strike price and the same expiration date.
The idea is that the profit to one position would offset the loss to the other, ensuring you have a net profit – this means you could take advantage of bitcoin volatility, regardless of which way the market moves. However, if the loss from one bitcoin option is larger than the gains to the other, you’d have a net loss.
The most common options strategy for hedging an existing holding is a covered call – this involves writing a call option for the same number of BTC that you already own. If the market price declined, the short call option would offset some of the losses to your BTC holding. If the market price increased, then you would likely have to sell your holding, but you’d have earned the option premium.
Discover the five popular options trading strategies.
1 Blockchain, 2020
2 Currently, we do not offer bitcoin options at IG
Publication date :