What Are Bitcoin Options: How to Own The World’s No. 1 Crypto for Less

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 in 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.

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. 

Key Takeaways:

• Traders choose to trade options because of the limited losses on premiums. Despite market volatility, options have proven to be highly useful in generating income, hedging against price movements and profiting from speculative trading. 

• Trading an options contract provides you with the benefit of controlling a larger trade size than the amount of capital you’ve used to initiate the position.

• Bitcoin futures, options and spot trading all serve different purposes to help traders capture market opportunities based on their risk appetites.

The Rise of Bitcoin: A Short History

Bitcoin (BTC) has grown to become a household name, evoking a wide range of emotions: curiosity, hope, fear and skepticism ... and much more.

Bitcoin’s growth over the past 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 arrived as a solution to scamming middlemen and unfair financial regulations. BTC grew from a value of $1 in 2011 to its all-time high of $68,000 in Nov. 2021. Currently, BTC’s price is hovering around $30K.

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 Sep 2021, it officially became legal tender in El Salvador, with more countries looking to follow suit. With the fourth Bitcoin halving approaching in the spring of 2024, Bitcoin’s price may soon regain and even surpass its glory.

Are There Options on Bitcoin?

Bitcoin options exist similarly to Bitcoin futures in the 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 a preferable mode 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 open up an avenue for investors and traders to speculate the asset's price at a fraction of the cost. Still, 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.

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 make 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? Most 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; it 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 premium paid.

Bitcoin Put Options

A Bitcoin put option gives the contract owner the right to sell Bitcoin at an agreed-upon price (strike price) later at a predetermined time (expiration date). In other words, it gives you the privilege of selling your stock. It usually follows a downward bias — that is, when an investor thinks the price of Bitcoin will decline rapidly or is bound to do so over a certain time frame.

In other words, this contract becomes valuable whenever the actual Bitcoin price falls below the strike price, before or on the expiration date. The holder can choose to exercise the option and sell Bitcoin at the higher strike price, even if the market price is lower. This allows traders to profit from a declining Bitcoin market, as they can sell at a better price than the current market value. And similar to a call option, the maximum risk a trader can absorb is the premium paid if the Bitcoin price doesn’t drop below the expected strike price.

Why Would Anyone Buy a Bitcoin Put Option?

To help you understand better, here's an example:

Assuming 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.

Bitcoin vs. Bitcoin Options: Profiting in Bear and Bull Markets

We already know why BTC is sold and is currently the biggest cryptocurrency by market cap: High demand. However, Bitcoin options (and other derivatives) are sold because they serve certain specific purposes, which we shall explore in detail below.

Hedging

Hedging is one of the most common reasons for trading futures or contract options.

To understand hedging, picture a garden close to a river or water pathway. It's safe to presume that such a piece of land will, sooner or later, get washed away by the force of water currents. In such a situation, the owner of the land builds a fence or hedge around it to shield it from erosion.

This example is a close, albeit simplistic, representation of hedging in the financial markets. Investors (and miners of Bitcoin) hold an asset whose value could be “eroded” or "washed off" by the forces of supply and demand. An options contract "shields" the value of the underlying asset — in this case, Bitcoin — by "locking" its value, i.e., the price at which Bitcoin can be traded for money.

Price Speculation

Traders and investors use contracts such as options to express their short-term sentiments (bullish or bearish) on an asset. 

To understand this better, remember that when an asset is bought, it’s usually believed that the asset will be more valuable in the future. When the asset records a substantial increase in value, you can profit by selling off an amount of it. 

What happens, however, when you feel a bearish run is imminent in the upcoming months? Although the underlying asset's price may bounce back after a while, by purchasing a put option, you would maximize your chance to make some profit. 

The Benefit Of Leverage

Here’s another reason Bitcoin options are increasingly traded over Bitcoin itself: Trading an options contract provides you with the benefit of controlling a larger trade size than the amount of capital you used to initiate the position. For example, for a relatively small premium amount of, say, $500 or $1,000, you can control one bitcoin, which could be worth $20,000 or more.

Expiration Dates

Expiration dates refer to the agreed date on which the contract option — the option of either buying or selling — is to be exercised. Note that not every Bitcoin options contract can only be fulfilled on its expiration date; some can, in fact, be exercised before the expiration date. Below, let's look at the two methods of contract fulfillment.

European-Style Options Contracts

European-style options contracts mandate the holder to fulfill only the terms of the agreement on the date of expiration. Even if a contract is in the money (ITM), the holder can't exercise their option until the set date, on which the fortunes of such a contract may have reversed.

A European-style contract requires higher accuracy in speculation than its American counterpart. At the time of this writing, major Bitcoin options trading platforms offer only European-style contracts.

American-Style Options Contracts

Options contracts styled in this manner give the holder the privilege of exercising the contract before the expiration date. If a contract is ITM, the holder can decide to use their trade option, thereby making a profit.

The American way of doing things implies that a much lower degree of accuracy in speculation is required. Making a profit requires the contract to be ITM any time: Between the date entered and the expiration date.

OTM vs. ITM vs. ATM

OTM, ITM and ATM are terms that are frequently discussed in options trading. Although they share fundamental similarities, they function differently in diverse scenarios. In fact, these terms describe the relationship between the current Bitcoin price and the strike price of an option.

An out-of-the-money (OTM) Bitcoin option refers to a current market price for Bitcoin that isn’t favorable for an option contract holder to execute their right. For example, if the strike price of a put option is $30,000, but Bitcoin is currently trading at $34,000, the put option is considered OTM. In this case, it wouldn't make financial sense for the contract holder to sell Bitcoin at $30,000 when the value of 1 BTC is higher on the spot market.

In contrast, an in-the-money (ITM) Bitcoin option is advantageous for an option holder when the current market price of 1 BTC is below the strike price. Using our previous example, if the strike price of a put option is $30,000 and Bitcoin is trading at $34,000, the put option would be considered ITM. The holder can exercise the option and sell their BTC at the higher strike price, even though the market price is lower.

When the current Bitcoin price is close to the option's strike price, an at-the-money (ATM) option works in favor of the contract holder, regardless of the market situation. For example, if the strike price is $30,000 and Bitcoin is currently trading at around $31,000, the put option is ATM. The option holder has to make a decision based on market predictions to determine whether it would be beneficial to exercise the option or not.

Depending upon the contract that they hold, traders can utilize these contracts to hedge against market unpredictability.

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 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, they must 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

Source: Robinhood Learn

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.

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 has a large role in determining option prices. 

• Rho shows the reaction of an option's price to changes in interest rates.

Bitcoin Options vs. Bitcoin Spot Trading vs. Bitcoin Derivatives

Depending on your trading interest, these contracts serve different purposes and yield different financial outcomes. When comparing trading options, it's crucial to understand the underlying trading mechanics and the flexibility from which these contracts derive their value.

Bitcoin Options

A Bitcoin option gives traders the right, but not the obligation, to buy (call option) or sell (put option) BTC at a predetermined price (strike price) on or before a specific date (expiration date). When compared to spot trading, options provide a more flexible trading opportunity with calculated risks, as traders may choose whether or not to exercise the option if it becomes unprofitable. The maximum loss is limited to the premium paid for the option contract.

Traders who seek to hedge their positions may prefer options, as they allow them to speculate on Bitcoin's price movements or take advantage of market volatility without committing to buying or selling the asset outright.

Bitcoin Spot Trading

Traders involved in spot trading prefer to buy or sell actual Bitcoin on cryptocurrency exchanges at the current market price, with settlement and ownership taking place immediately. Unlike options or futures trading, the spot market allows traders to directly own the underlying asset for transactions or long-term investments.

When compared to options, spot trading is best suited for beginning and intermediate traders who want direct exposure to Bitcoin and are interested in using it for various purposes or holding it for potential long-term gains.

Bitcoin Derivatives and Futures Trading

Bitcoin derivatives are financial contracts that derive their value from the underlying price of Bitcoin. These include Bitcoin futures and perpetual swaps. For example, Bybit Futures Contracts allow traders to trade contracts with a specified expiration date, while Bybit Perpetual Swaps don’t expire and can be held indefinitely.

In other words, derivatives enable traders to speculate on Bitcoin's price without owning the actual asset. They offer leverage, allowing traders to control larger positions with a smaller amount of capital. Due to leverage, derivatives carry higher risk and complexity than spot trading or options. Thus, they’re more suitable for intermediate and advanced traders.

Which Is Better for Beginners and Intermediate Traders?

For beginners:

• Bitcoin spot trading is generally the best starting point for newcomers to the cryptocurrency market. It provides a straightforward way to buy, own and use Bitcoin without getting involved in complex financial contracts.

• Spot trading allows beginners to focus on understanding Bitcoin's fundamentals and price movements while avoiding the potential risks associated with derivatives or options.

For intermediate traders:

• Once traders have gained some experience and a deeper understanding of the market, they may explore Bitcoin options as a risk management tool or as a way to take advantage of specific price scenarios.

• However, intermediate traders should exercise caution when considering Bitcoin derivatives, due to the higher risk and complexity involved. Derivatives trading can amplify both profits and losses, making it more suitable for experienced traders who have a solid grasp of risk management strategies.

Ultimately, the best choice depends upon an individual's knowledge, trading goals and risk tolerance. Beginners should start with spot trading to get acquainted with Bitcoin, and as they progress, they can explore options and derivatives with proper research and understanding.

How to Trade Bitcoin Options

Bitcoin options are offered on several exchanges, which have different methods of allocating contracts. For example, on a crypto exchange, the options contract is upheld directly between the customer and the exchange.

To enter a contract option, the user chooses the amount of Bitcoin they wish to trade the options contract on, thus determining the premium. Since the trade takes place between the user and the exchange (using a computer program), if the value being lost by the user were to pass a threshold, the user would be liquidated to restrict losses, with the only money lost being the premium.

On some other exchanges, a user "writes" a contract and waits for their contract to be matched by another who orders to purchase a contract with similar terms to the writer. The exchange regulates this trade, and a fee is charged to ensure fairness. 

Source: Bybit

On Bybit, Bitcoin options can be bought via Derivatives → USDC Options (see image above). For a step-by-step guide on how to do so, please click here.

Trade Bitcoin Options on Bybit Today

Are Bitcoin Options a Good Investment?

To the Bitcoin miner, options can keep their rewards at reasonable levels when implemented carefully. To the Bitcoin investor, Bitcoin options are a good way to speculate on the rise and fall of Bitcoin. Even if BTC is bleeding red, you can make money like a true businessperson.

To the investor who wants a "feel" of the market without prior experience with Bitcoin or cryptocurrencies, no worries: There's an option (pun intended) for you in the form of Bitcoin options contracts. (Editor’s note: Please ensure that you’re educated on the risks involved. Only go for options trading if you’re comfortable stomaching the level of risk).

Are Options Riskier Than Spot Trading?

Options trading often involves predefined losses (limited to the premium paid), whereas spot trading exposes traders to potentially unlimited losses if the market moves significantly against their position. However, the complexity and limited time frame of options can make them riskier for inexperienced traders.

Overall, both options and spot trading carry risks, which can vary based on the trader's approach, knowledge and risk management strategies. It's crucial for traders to understand the risks associated with their chosen trading method thoroughly and to trade within their risk tolerance and financial capacity.

Conclusion

The goal of every trader and businessperson is to make a profit. No one sets out to lose. Due to the sophisticated nature of economic systems, this goal is now more achievable than ever. With the growth of cryptocurrencies, Bitcoin options have been gaining popularity in recent years.

On the flip side, more ways to make money also means more ways to lose it. Crypto options require caution, not (ideally) a mindset of "get rich quick." In order to maximize your gains, you'll need plenty of patience, as well as the ability to spot opportunities and act on them quickly.

We hope this guide has helped you grasp the fundamentals of BTC options. As long as you do your research and understand the risks, you’ll be set to purchase your first Bitcoin option.

#Bybit #TheCryptoArk