Trading crypto on an exchange can be simple and rewarding. But veteran investors and those involved in traditional markets may still want more. Crypto options trading is one such avenue that expands investment opportunities. They are another financial instrument or “derivatives” that give investors more means to grow their money.
What Is Crypto Options Trading?
An option contract is a financial agreement that entitles you to buy or sell an asset at a pre-determined price. But unlike futures contracts, you have the option of exercising it or not. You are not obligated or forced to fulfil the contract.
Recently, this type of contract has also made its way into crypto trading. This is highly beneficial for investors in an uncertain and volatile market as options can be used to reduce risk.
How Does Options Trading Work?
Every crypto option has a few important features – premium, strike price and expiry date. The premium is the cost of buying the contract. The strike price is the price at which the contract buyer has the right to buy or sell the underlying asset. Finally, the expiry date is the final settlement date of the contract.
There are two styles of options – American and European. American options can be exercised at any time before the expiry date. Meanwhile, European options can only be exercised on the settlement date.
The premium of a contract is based on factors such as its remaining duration, the price of the underlying asset, expected volatility between the start and end date of the contract and the expected return.
Read more: Crypto Investing vs Crypto Trading
Types of Options Contracts
A call option is a right to buy the underlying asset at a specified price. You enter into this contract if you believe the strike price of the contract will be lower than the market price on the expiry date. This allows you to purchase the asset at a price lower than the current rate.
For example, suppose you want to buy an Ethereum call option expiring in 5 days. It has a strike price of $1,200 with a premium of $15. If the price of Ethereum rises from $1,200 to $1,300, then you will choose to exercise the option and buy Ethereum at the strike price. This will give you a profit of $85, which is (current price – strike price – premium).
A put option is a right to sell an asset at a pre-determined price. If you believe the strike price of the contract will be higher than the market price, this is the option contract to choose. Therefore, you can sell your crypto assets at a higher price than the market rate.
Suppose you want to buy an Ethereum put option. Like the example above, it has a premium of $15 and a strike price of $1,200. If the price of Ethereum falls from $1,200 to $1,100, you will exercise the option to make a profit. Your gross profit will be $85 (strike price – market price – premium).
How To Trade Crypto Options?
The process of options trading begins by creating a call or put option. This contract has a strike price and an expiration date. Next, the contract is listed on a crypto exchange that supports options trading. Upon purchasing the contract, the buyer can choose to trade it further or exercise the option.
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To begin trading, you must open an account on a crypto options exchange. Once you create an account and deposit your funds, you can immediately start trading options.
What Are Some Crypto Options Strategy?
A bull market is a situation where the prices of most assets in the market trend upwards. In this case, buying call options is the best way to earn a profit. The advantage of buying call options is that you also limit your risk as you are not obligated to exercise the option in case the price fails to rise.
Put options are the best choice in a bear market, where most assets have falling prices. This option allows you to sell at a higher price and earn a profit even when the market trends downwards.
Read more: Crypto Trading Strategies
Is Crypto Options Trading Different From Traditional Options Trading?
There are two main factors that separate the traditional market and crypto market – time and volatility.
Financial markets globally usually operate from Monday to Friday 9:00 am to 5:00 am. It is only possible to make trades during this window on weekdays. If you wish to make a trade at night or on a weekend, the order will only be fulfilled on the next trading day. By contrast, the crypto market operates 24/7, all year round. There is no downtime in trading.
Second, the crypto market is more volatile than traditional markets. This can lead to higher profits, but the risk is also much higher. Traditional markets are relatively more stable.
Read more: Futures Trading Vs Margin Trading
Benefits of Crypto Options
- Risk Management: The main benefit of options over outright ownership or futures contracts is the risk factor. If the market does not move in the right direction, you can choose not to exercise the contract. In this case, you only lose the premium and not the entire purchased amount.
- Liquidity: Derivative markets have very high demand and are more liquid than standard crypto markets. This makes it easier and faster to complete trades.
Risks of Crypto Options Trading
- High Risk – The premium of an options contract can be highly volatile, where prices can move almost 90-100% in a single day. This makes the market very risky for users that invest heavily in options.
- Regulation – The crypto industry is largely unregulated. If you lose your money or get scammed by a fake platform, you can avail almost no government protection.
Options trading is a lucrative opportunity to diversify your portfolio and manage risk in uncertain markets. It expands the crypto market to include more features of traditional finance and attracts more traders. But it can also be risky and lead to massive losses if you are not careful with your investments. It is essential to do your research and consider the pros and cons before you invest your money.
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