Bitcoin Options and How to Trade Them
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Crypto options empower investors to buy or sell cryptocurrencies at predetermined prices, offering a unique way to profit from market movements without owning the underlying assets.
From different contract types (American vs. European) to call and put options, comprehending the nuances of options positions and terminology is crucial to effectively trade Bitcoin options.
What are crypto options?
Crypto options are a form of derivative contract that grants investors the right to buy or sell a specified cryptocurrency, such as Bitcoin, at a predetermined price and date. This innovative financial instrument allows traders to capitalize on market movements without owning the underlying asset.
The different types of options contracts
Here’s a look at the different kinds of options contracts, specifically American vs. European.
American vs. European options
There are two main types of crypto options contracts: American and European options. American options provide flexibility, allowing investors to exercise their rights at any point before the expiration date.
On the other hand, European options limit exercise rights to the specified expiration date. The choice between them involves considerations of flexibility, cost, and risk.
Both American and European options grant you a contractual right to buy or sell an asset at a predetermined date and price, commonly known as the expiration date and strike price.
The key distinction lies in exercise rights, which pertain to the ability to enact the contract, whether for buying or selling the underlying asset.
American Options: Investors holding American options can exercise their rights and close a position at any time before the designated expiration date. This inherent flexibility contributes to the widespread popularity of American options.
European Options: In contrast, European options allow investors to close a position and terminate their contract solely on the specified expiration date. Despite the apparent appeal of American options, European options have a cost advantage, as their premiums (the price to initiate the contract and secure the option) are generally lower.
Moreover, proponents of European options argue that they entail lower risk due to the fixed expiration date. This fixed date facilitates a more straightforward estimation of potential losses or gains when initiating a position, making strategic planning more accessible. Consequently, European options often prove more approachable, especially for those new to options contracts.
Call options vs. put options
In short, a call option grants the right to buy an asset at a specific price on a designated date, while a put option provides the right to sell an asset at a specific price on a specified date.
Crypto call options
Call options are non-obligatory, meaning investors can choose not to execute the option, limiting potential losses to the premium paid. The breakeven point, calculated by adding the strike price and premium, is a reference for assessing profit or loss as the crypto's value fluctuates.
Options are priced per share and typically sold in bundles of 100 shares. So if a call option is quoted at $200, the actual cost would be $20,000.
Crypto call option example
Let’s imagine a scenario where an investor is optimistic about the future of Ethereum, priced at $2,000 per unit.
They decide to purchase a call option with a $2,500 strike price, expiring in six months, at a premium of $300. The breakeven point would be $2,800 ($2,500 + $300).
If Ethereum surges to $3,000, the profit per unit would be $200, totaling $20,000 for the contract.
Conversely, if it only reaches $2,600, the loss per unit would be $100, and the maximum potential loss would be the $30,000 premium paid.
Crypto put options
On the flip side, a put option in the crypto realm mirrors its traditional counterpart. Investors pay a premium for the right to sell a cryptocurrency at a predetermined strike price until the option's expiration.
The non-binding nature of put options allows investors to sell the contract for profit if the crypto's value drops significantly. The breakeven point, determined by subtracting the premium from the strike price, is crucial to evaluating profit or loss.
Crypto put option example
Consider a situation in which an investor believes Bitcoin, currently valued at $50,000 per unit, is overpriced.
They decide to purchase a put option with a $45,000 strike price, expiring in three months, at a premium of $500. The breakeven point would be $44,500 ($45,000 - $500).
If Bitcoin plunges to $40,000, the profit per unit would be $5,500, totaling $550,000 for the contract.
However, if it stays above $45,000, the investor can let the option expire, incurring only the premium cost.
What is an option premium?
The option premium is the market price of the option contract paid to the seller or writer, regardless of whether the right is exercised. Calculated based on factors like the underlying asset's price, market volatility, contract length, and strike price, the premium plays a crucial role in option trading dynamics.
Options terminology: ITM vs. OTM vs. ATM
Understanding the concepts of in-the-money (ITM), out-of-the-money (OTM), and at-the-money (ATM) is essential.
ITM: An option is ITM when exercising it would be profitable.
OTM: An option is OTM when it wouldn't be profitable.
ATM: An option is ATM when the asset's current market price equals the option's strike price.
This terminology influences trading strategies and risk assessment.
What’s an option position?
The term "position" in the context of options refers to the financial stance taken regarding a particular contract. Four basic options positions exist: buying a call option, selling a call option, buying a put option, and selling a put option.
Each position has implications for long or short positions, with "long" indicating a bet on a price increase and "short" signaling a bet on a price decrease. These positions contribute to the complexity of options trading.
Crypto options trading explained
Navigating crypto options trading involves several key steps. First, develop a comprehensive trading strategy rooted in understanding market dynamics and crypto price movements.
Opening positions based on this strategy, monitoring the market vigilantly, and knowing when to cash out are crucial aspects of successful crypto options trading.
Once you plan to trade crypto options, sign up with a crypto exchange offering options trading. Several exchanges offer options trading with varying fees and supported assets:
Binance provides options trading for BTC, ETH, BNB, XRP, and DOGE, with a 0.03% transaction fee and a 0.015% exercise fee. This platform is accessible globally, excluding the United States.
Bybit supports options trading for BTC and ETH, featuring a 0.02% trading fee, a 0.015% delivery fee, and a 0.2% liquidation fee. It is available globally, excluding the US.
Crypto.com facilitates options trading for BTC and ETH, imposing a $1 exchange fee and a $0.99 technology fee, exclusively for US users within the mobile app.
Deribit supports options trading for BTC and ETH, with a fee structure of 0.03% of the underlying asset's value and is accessible globally, excluding the US.
OKX offers crypto options trading for BTC and ETH, with tiered maker/taker fees and trading fees, and it caters to a global audience, excluding the US.
Crypto options trading strategies
Crypto options come in two main types: calls and puts. Savvy crypto traders can strategically combine these to create a range of trading possibilities. Here is a list of ten crypto options trading strategies:
1. Covered Call
What: Buy an asset and short a call on the same asset.
Why: Generate income (option premium) in a stable market.
Trade-off: Obligation to sell the asset at a predetermined price.
2. Protective Put (Married Put)
What: Purchase an asset and put options for the same amount.
Why: Acts as insurance, setting a price floor in case of a sharp price drop.
3. Protective Collar
What: Combine a long position, a put option, and a call option.
Why: Shields against downside risks after substantial gains.
Trade-off: Limits potential further gains if the asset price rises.
4. Long Call Spread
What: Simultaneously buy and sell call options with different strike prices.
Why: Capitalize on a moderate rise in the asset's price.
Trade-off: Limited upside, reduced net premium spent.
5. Long Put Spread
What: Purchase and sell put options with different strike prices.
Why: Benefit from a bearish sentiment, limiting both losses and gains.
6. Long Straddle
What: Purchase a put and call option on the same asset with the same strike price and expiration date.
Why: Anticipate a significant price move without predicting the direction.
Trade-off: Limited loss to the combined cost of options.
7. Long Strangle
What: Simultaneously buy OTM call and put options on the same asset.
Why: Expect a large price movement with lower cost compared to straddles.
8. Long Call Butterfly Spread
What: Combine bull and bear spreads using three different strike prices.
Why: Fixed risk and capped profit strategy.
9. Iron Condor
What: Execute a bull put spread and a bear call spread on the same asset.
Why: Exploit low volatility for a net premium with perceived high probability.
10. Iron Butterfly
What: Similar to the iron condor, involving the sale and purchase of puts and calls at different strike prices.
Why: Balanced strategy with a defined risk-reward structure.
Mastering these strategies empowers traders to navigate diverse market conditions, managing risk while unlocking the full potential of returns.
Crypto options trading benefits
Crypto options trading presents a range of potential advantages. Leverage allows traders to control larger positions with relatively small capital. Flexibility in strategy caters to both simple and complex trading approaches.
Options are valuable for hedging, diversification, and strategic positioning within a broader crypto portfolio. Additionally, defined risk and the potential for high returns contribute to crypto and Bitcoin options trading appeal.
Crypto options trading risks
While the potential benefits of crypto options trading are enticing, it's crucial to understand the corresponding risks. The complexity of options makes them less suitable for new investors.
Potential losses, leverage risks, liquidity issues, short selling risks, regulatory uncertainties, and the volatile nature of cryptocurrencies all contribute to the risk landscape. Traders should carefully assess and manage these risks before engaging in options trading.
Differences between spot trading vs. options trading
A fundamental distinction lies between spot trading and options trading. Spot trading involves the direct ownership of the traded asset, while options trading entails holding a contract providing the right to buy or sell an underlying asset at a later date.
The differences extend to capital requirements, profit and loss potential, complexity, purpose, ownership, duration, and liquidity.
Differences between crypto options vs. crypto futures
Crypto options and crypto futures represent two distinct derivatives. In options, holders have the right but not the obligation to buy or sell, while futures obligate both buyer and seller.
Additional disparities encompass capital requirements, profit/loss potential, complexity, purpose, expiration, settlement methods, liquidity, and contractual rights and obligations.
How are crypto options taxed?
Generally, profits from crypto options are subject to crypto capital gains tax. A comprehensive understanding of crypto options taxation is essential, and platforms like ours at TokenTax can provide valuable assistance in navigating the tax landscape.
How TokenTax can help with your crypto options
At TokenTax, we offer specialized assistance in managing your crypto and Bitcoin options taxes. With the help of our software and expertise, users can navigate the complexities of tax regulations to ensure compliance and accurate reporting of crypto options transactions.
However complex your crypto and Bitcoin options trading, our team of crypto tax professionals are available to help.
Schedule a FREE crypto tax consultation
Crypto options trading FAQs
Here are answers to frequently asked questions about Bitcoin options and Bitcoin options trading, and how to trade crypto options.
Are there crypto options trading platforms in the USA?
Yes, there are crypto options trading platforms in the USA. However, the options are somewhat limited due to the stringent regulatory environment. Notably, Crypto.com is a CTFC-approved and regulated provider in the United States.
What are crypto binary options?
Crypto binary options are a specific type of options contract where two parties are assigned outcomes based on whether the option expires in or out of the money. These contracts are higher risk, resembling a winner-takes-all bet, but offer fixed payouts and losses for clearer risk assessment.
Where to trade crypto options?
Can you trade options on crypto?
Yes, and crypto options trading, especially for Bitcoin options, is increasingly common. It provides investors with access to potential profits while mitigating risks compared to other crypto derivatives products.
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