The world of investing is characterized predominantly by the maximization of profits. Every year, numerous innovations spring up to help investors profit in whatever capacity and whichever field an opportunity presents itself. One such financial instrument is called Bitcoin options.
Though popularized only in recent times, the concept of options trading dates back to the 17th century. This concept is founded on a financial theory that gives certain permissions and withholds certain rights. Essentially, options are contracts that give an investor or trader holding an option the right (not the obligation) to buy or sell an asset at a predetermined price and date.
Options belong to a class called derivatives, and a key attribute of assets that fall into this class is dependency. This means that the value of options is derived from that of other instruments such as cash, bonds and other derivatives.
Options track underlying assets and then reflect the value to be traded. Across industries, they have proven to be highly useful in generating income, hedging against price movements and profiting from speculative trading.
While the concept can be technical and rather confusing, one thing is for sure: Options are a profitable tool that can definitely become an investor's best friend. In this article, let’s discuss everything you need to know about a particular type of crypto option: Bitcoin options.
The Rise of Bitcoin: A Short History Over the past few years, Bitcoin has grown to become a household name evoking a wide range of emotions: Curiosity, hope, fear, skepticism ... and much more.
Its growth over 12 years took the world by surprise. First appearing in a white paper in October of 2008, pseudonymous author(s) Satoshi Nakamoto introduced a concept that would later give centralized financial institutions worldwide a run for their money.
Birthed out of a desire to correct the flaws and misappropriations of the existing financial systems, Bitcoin came as a solution to "rip-off" middlemen and unfair financial regulations. From a value of $1 in 2011 to reaching an all-time high of $68,000 in Nov. 2021, Bitcoin has experienced crazy growth.
Since 2011, Bitcoin has grown from its first use case (as a medium of exchange for pizzas) to being adopted by millions of users and corporations worldwide, using it in their day-to-day transactions. In Sept. 2021, it officially became a legal tender in El Salvador, with more countries looking to follow suit.
While Bitcoin has yet to fully mature, it’s come a long way and kick-started a new chain of events in the world's financial systems.
Are There Options on Bitcoin? Yes, there are. Bitcoin options exist: Similar to Bitcoin futures, they’re a form of derivatives. They can be defined as "contracts that give an investor or trader the right to buy or sell Bitcoin (but not the obligation) at a given price (strike price) and a specific date (expiration date)."
Bitcoin options trading is preferable to buying Bitcoin, because the cost incurred to buy an option (a premium) is less than that of the actual asset. As opposed to buying and holding Bitcoin, Bitcoin options give you the leverage to take speculative positions (i.e., upward or downward) on BTC's price movement.
Considering how volatile the cryptocurrency asset is, Bitcoin options are a beautiful concept. They allow you to profit from the downward movement in price without actually suffering the loss of holding the currency itself. Bitcoin options also allow you to profit from a spike in price as if you were holding the actual coin.
In addition, Bitcoin options are an excellent choice for investors and traders who understand how it works. Apart from the high volatility in Bitcoin that creates wide profit margins, losses are limited only to the premium paid to open the positions. This uncapped profit potential and capped losses are some of the best features of Bitcoin options trading that makes it attractive and in demand.
Bitcoin Call Options A Bitcoin call option is an agreement that allows a call option owner to buy an agreed-upon amount of Bitcoin for a particular price (also known as the "strike price") at a particular time (expiration date).
Consider the following (hypothetical) scenario: Let's say you believe that the price of a piece of land will go up in a couple of months. You discover that you can reach an agreement with the seller that would allow you to purchase the land at a particular price, and mandate the seller to sell it to you ... all this at the small cost of a fee (premium). Would you accept the offer? Probably. This same logic applies to Bitcoin call options.
To clarify, the agreement merely gives you the "option" to buy the land at that time and isn't mandatory. If you don't have the funds at that time to close the deal, all you have to do is forfeit it and lose the fee paid.
Bitcoin Put Options This instrument allows the contract owner to sell Bitcoin at an agreed-upon price later. Simply said, a Bitcoin put option gives you the privilege of selling your "stock." It usually follows a downward bias — that is, when an investor feels the price of Bitcoin will decline rapidly, or is bound to do so over a certain time frame.
Why Would Anyone Buy a Bitcoin Put Option? To help you understand better, here's an example: Mr. Stone is a fruit seller who notices that fewer people buy more fruit at a particular time of the year, which forces the price of fruits down. Throughout this period, he consistently runs his business at a loss, because he has to sell his produce at a lower price than what he bought it for.
One day, he hears of a company that wants to buy his fruits at a predetermined price, even when that price is lower than the market rate. This opportunity allows him to sell his goods to them at that price and hedge against decline, even when other fruit sellers have no choice but to make do with less-than-ideal selling rates.
Mr. Stone and the company enter an agreement that mandates the company to buy his goods at the predetermined price within that period. This contract is sealed with a fee (premium). If the company refuses to act on the contract, Mr. Stone gets to keep the premium that was paid.
It's worth noting that Mr. Stone gets to decide the premium paid based on the perceived demand for his fruit at that time. The same logic applies to Bitcoin put options.
Holding And Writing Bitcoin Options "Holding and writing" in options trading is another way to express the act of buying and selling. Like buying and selling, there are two sides to an options contract; On one side is the "holder," or buyer, and on the other is the "writer," or seller. This two-sided concept covers both put and call options — meaning that you can go long or short on both.
The connection between a holder and a writer is the premium paid. When an investor decides to "hold" an option, then they’re obligated to pay a premium that gives them the right to buy or sell Bitcoin.
The reverse is true of "writing." When an investor decides to “write,” they sell their right to decide to the holder. If the holder decides to act on the options contract, the seller will have to keep their word and relinquish their right. They only get paid the premium for the decision.
The Greeks
Certain terminologies are used to understand the factors responsible for an option's price in Bitcoin options trading. These terms are called the "Greeks." They decide how much you pay to open an options contract as a holder, or how much you receive selling an option as a writer. Although you’ll see terms like Delta and Theta, please don't be intimidated — we're not going back to Math/AP class. Here are the five members of the Greeks:
Delta reads how reactive an option's price is to a point move in Bitcoin's underlying price.
Gamma denotes how much the Bitcoin option's delta moves, for every point move in the underlying Bitcoin price.
Theta measures the rate of decay of a Bitcoin option with time. The lower the theta, the farther from the expiration date; the higher the theta, the closer to the expiration date.
Vega keeps a tab on how sensitive an option is to the implied volatility in the underlying Bitcoin price. It measures the rate of change of an option's premium, with a 1% change in volatility. Bitcoin is a volatile asset, so vega holds a bigger vote in determining option price.
Rho shows the reaction of an option's price to changes in interest rates.