What are Bitcoin and Ethereum Options
Options trading has gained popularity within the cryptocurrency market.
Crypto options provide traders with the opportunity to participate in and profit from the crypto market even with relatively low capital.
This article shall explore the definition of crypto options, their operations, categories, examples, benefits, and challenges.
What are Options in Crypto?
Crypto options are derivative agreements that give the holder of the options the right to buy or sell crypto assets at a pre-determined price by a set future date.
Crypto options do not create an obligation to buy or sell the agreed-upon crypto assets.
Options grant their holders a right which may or may not be exercised.
Crypto options come at a purchase price known as Premium. This refers to the amount a person pays in exchange for holding an option that grants a trader a right to buy or sell crypto assets at a future date.
Call and Put Options
Options can be exercised in two ways, either as a call option or a put option.
Call Option
A call option gives a holder the right to buy a crypto asset at a predetermined price and sell at a future date.
A call option is usually exercised during the bull run or when the holder speculates that the price of a crypto asset is about to rise.
Here is a simple explanation on how call options work using an imaginary coin called NextCoin
If you speculate that the price of NextCoin, which is currently selling at $1200 will rise, you can purchase a call option for 10 NextCoins at a strike price of $1500 with an expiry date of two weeks from today.
The call option grants you the right to buy 10 NextCoins at $1500 each in the next two weeks. At the expiry date of the two weeks, if the price of NextCoin rises and is selling for $1700, you make a profit.
This is because the call option grants you the right to buy NextCoin at a rate of $1500/1 on the set maturity date and sell for the current price.
Therefore, if the asset is currently selling at $1700, you make a profit of $200 per NextCoin, which sums up to $2000 since you purchased an option for 10 NextCoins.
One important thing to note about options is that you do not actually “buy” the assets. A call option is exercised under the assumption that the holder purchased the underlying assets, thereby enabling the holder to sell the assets he is assumed to have bought.
In a situation where the holder's speculation is wrong and the price of the assets falls below the predetermined price, the holder will make a loss since he will be selling for a lower price than the price he is assumed to have bought the assets.
However, options do not create an obligation on the holder. The holder of a call option can decide not to exercise the option. The only loss that will be occasioned is the premium, which is the price he bought the option.
Put Option
On the other hand, put options grant the holder the right to sell an asset at a predetermined price at a set future date.
Put options are usually bought during a bear market or when the holder speculates a fall in the price of assets within a particular period.
Using the same example of NextCoins currently selling at $1200, a trader may purchase a put option to sell 10 NextCoins at a strike price of $1000 in the next two weeks.
If NextCoin falls below $1000 to $700 on the date of expiry, the trader makes a profit of $3000 at the rate of $300 per NextCoin.
The put option gives the right to a holder to sell NextCoin at the current selling price under the assumption that he bought the coins at the predetermined price of $1000.
Where the assets rise at the end of the two-week time frame or do not experience any fall in price, the option to sell becomes unprofitable. A trader may refuse to exercise the option and let it expire. The only loss sustained is the price he bought the option.
Traditional Options vs Crypto Options
| Traditional Options | Crypto Options |
| Traditional options involves the right to trade assets like physical commodities, stocks and forex pairs | Crypto options involves the trade of crypto assets such as BTC and ETH and crypto-related assets such as Bitcoin and Ethereum ETFs |
| Traditional options can be traded publicly on public stock exchanges. | BTC and ETH are general traded on Decentralized or Centralized exchanges whilst Bitcoin and Ethereum ETFs are traded on public stock exchanges |
| Traditional options can be traded privately between individuals Over-The-Counter (OTC) | Crypto options can also be traded privately between parties over the counter |
| Traditional options generally follow the European style of options trading | Crypto options mostly use the American style of options trading |
European vs American style
| European Style | American Style |
| The European style of option trading only allows the options to be exercised on the set date. | American style of option trading allows the options to be exercised at any time before the expiration date. |
| The right to exercise the option expires once the set date passes. | It is flexible and gives traders the opportunity to have more control in the market. |
| The European style of option trading is primarily used within traditional options and less common in crypto options trading. | It is more common in crypto option trading.
|
Bitcoin and Ethereum Options Explained
Bitcoin Options
Bitcoin Options grant traders the right to buy or sell at a predetermined price on a set future date.
Bitcoin Options are purchased for profits and income generation through speculation. Other use cases of Bitcoin options may include hedging which offsets the losses resulting from the incessant volatility of BTC market price.
BTC options trading is available at Centralized exchanges like Kraken, Deribit, Binance, Bybit, Chicago Mercantile Exchange (CME).
Some examples of Bitcoin ETF options are BlackRock's iShares Bitcoin Trust (IBIT) and Bitwise Bitcoin (BIB), which can be traded on public stock exchanges like Chicago Board Options Exchange (CBOE).
Ethereum Options
Ethereum Options are financial derivatives that give holders the right to buy Ethereum at a future date.
Ethereum options have expanded options trading in decentralized finance (DeFi), offering benefits beyond volatility hedging and profit-making.
There has been a rise in the development of decentralized protocols that support options trading in a decentralized environment, relying on liquidity pools and Automated Market Makers (AMM). Some examples are Opyn, Hegel, Thetanuts Finance, Premier Blue, etc.
These protocols also created a yield farming system based on options trading.
For example, Hegic rewards traders who create option contracts and liquidity providers who provide liquidity for options traders with the governance token HEGIC.
Opyn also allows option traders to earn yield through governance tokens and collateral tokens from Aave and Compound.
How Crypto Options Work (Step-by-Step)
- Select an exchange that supports options trading of Bitcoin or Ethereum (Deribit, Kraken)
- Fund your account preferably with USDT or other stablecoin.
- A buyer purchases a call or put option by paying an amount known as premium to the seller (usually the crypto exchange or public stock exchanges for BTC/Eth ETFs)
- The buyer sets a strike price, which is the predetermined price at which he speculates that the asset will rise above or fall below.
- The buyer sets a future day upon which the option is exercised, known as the expiry date.
- On the expiry date, the buyer exercises the option if it is profitable, and if it is not, he refuses to exercise the option and waits for the option to expire.
- The premium is lost either way whether the buyer is in profit or loss.
Types of Crypto Options
Cash-Settlement vs Physical-Settlement Options
| Cash Settlement | Physical Settlement |
| Cash settlement means that the option is settled in cash, based on the price difference between the determined price and the market price. | Physical settlement involves the settlement of the options by delivering the underlying asset to the option holder. |
| It does not require delivery of the underlying assets | It is more common with options trading that involves a physical commodity. |
| No extra costs for delivery or logistics are incurred. | It is preferred by traders who wish to hold the assets for the long-term. |
| It is preferred by traders looking for quick profit in the market | Extra costs are usually incurred for the delivery of the asset. |
| Most crypto options are settled with cash settlement where the price difference is paid in USDT to the option holder. | In the few cases where exchanges physically settle crypto options, the underlying assets, such as BTC or ETH are sent to the options holder |
Vanilla vs Exotic Options
| Vanilla Options | Exotic Options |
| Vanilla Options are straightforward types of option trading. | Exotic Options are more complex types of option trading |
| They have fixed trade features that are not customizable. | The expiration date and payout structure of exotic options are customizable. |
| They are often traded on organized exchanges. | Exotic Options are traded Over-The-Counter (OTC) |
| They have limited risks with less potential for high returns | They are riskier and have more potential for higher returns. |
| Vanilla Options are easy to trade and beginner-friendly | Exotic Options are harder to trade and not suited for beginners. |
Benefits of Trading Bitcoin and Ethereum Options
- Hedging: Crypto options can be used to hedge against adverse price movements.
- Profit- making: Crypto options allow traders to make profits during the bull and bear season.
- Leverage: Crypto Options allow traders to control a larger position in the market with a relatively small amount of funds.
- Limited Risk: There are no obligations to exercise the options, unlike in Futures trading. Hence, only the premium is lost.
- Income through options selling: Option sellers could earn an income through the payment of premium.
Risks and Challenges of Trading Bitcoin and Ethereum Options
- Complexity: Options trading can be very complex and requires a strong grasp of the concept. This makes it less suitable for beginners and new investors.
- Loss of Premium: Investors lose the amount spent on premium whether the option is exercised or not.
- Volatility: The speculations of investors and traders are often challenged by the notorious volatility of the crypto market.
- Insufficient Liquidity: Some exchanges do not have sufficient liquidity and may not be able to offer a smooth trading experience or pay out profits.
- Regulatory uncertainty: Regulations of crypto assets are still unclear in many jurisdictions. This could challenge the validity of option contracts.
Where to Trade Bitcoin and Ethereum Options
- Centralized Exchanges (CEX): Some centralized exchanges support Bitcoin and Ethereum options trading. These exchanges include CME, Deribit, Binance, Kraken, Bybit, etc.
- Decentralized Exchanges(DEX): Certain decentralized exchanges support options trading of Bitcoin and Ethereum. Some examples are Premia Blue Opyn, Lyra, Thetanuyts, Hegel, etc.
- Public Stock Exchanges: These are less common platforms for trading Bitcoin and Ethereum Options and are more common in trading Bitcoin and Ethereum ETFs. An example of a public stock exchange that supports trading of Bitcoin and Ethereum Options is the Chicago Board Options Exchanges (CBOE).
Investors are advised to select CEX or DEX with advanced security features, a well-designed User Interface (UI), relatively low premium fees, and active customer care service.
Pro Tips for Beginners
- It is necessary to learn the basics of option trading.
- Start trading with small amounts.
- Focus on options with better liquidity, such as Bitcoin Options to avoid liquidation.
- Practice with testnets or paper trading if available
- Always define your risk before entering into any position.
- Carry out due diligence before any trades and avoid hasty trades.
Conclusion
Crypto options offer a flexible approach for investors and traders to make profit regardless of the market conditions.
Bitcoin and Ethereum Options offer an opportunity for transfers to access ETH and BTC and diversify their portfolio.
However, crypto options trading is not without risk, hence, traders are advised to learn the basics of option trading and trade responsibly.
Traders and investors can further manage their crypto assets and portfolio with trusted and secure platforms like Switchere.
Please be advised, that this article or any information on this site is not an investment advice, you shall act at your own risk and, if necessary, receive a professional advice before making any investment decisions.
Roman Klochko