There are currently many derivatives used in the crypto market. Together they increase the liquidity of the market. In addition, they improve market equilibrium conditions by providing tools for arbitrage opportunities. Crypto options are also a form of derivatives that make this possible!
In this article, we will be discussing Crypto options, how they work and their pros.
What are Crypto Options?
Options are a form of derivatives. Derivatives are financial instruments used to hedge or speculate on assets. Crypto options are a form of options. However, the core functionality remains the same. They give the buyer of an option the right to buy or sell an asset at a predetermined time and price.
There are two types of options in the market: call options and put options. When you decide to exercise an asset, a call option is used to buy and a put option is used to sell the asset. The main difference between futures and options is that you are under no obligation to exercise the option. On the other hand, futures don’t give you that freedom.
Like other derivatives, options are simply contracts that allow traders to speculate on the future price of the underlying asset and can be settled in cash (USD) or actual cryptocurrencies (bitcoin, ether, etc.).
Deribit, the world’s largest crypto options platform, provided cash-settled crypto options contracts, while OKEx, the second-largest crypto options exchange, physically delivered crypto assets to investors in exit trades. For example, when traders successfully close bitcoin options trades on OKEx, they make bitcoin profits on settlement.
How Do Crypto Options Work?
There are two types of crypto options:
American: The buyer can exercise the contract at any time before the expiration date
European: The buyer can only exercise the contract once it has expired
It’s worth noting that while European options can only be exercised at expiration, they can still be traded (sold to someone else) or closed early if the buyer so chooses.
There are two different types of options:
Call: The right to buy the underlying asset
Put: The right to sell the underlying asset
The options trading process follows: the option seller “writes” (creates) call and put option contracts. Each contract has an expiry date – when the contract must be settled – and a “strike price”. This refers to the price at which the buyer of the contract has the right to buy or sell the underlying asset at expiration (or before if it is an American option).
The option seller then lists the contract on a crypto options exchange. Sometimes options buyers can also place orders on exchanges that options sellers can sell to.
The cost of an option is often referred to as the “premium”. If that sounds like something like insurance, in many ways it is. For example, people who buy put options do so to protect the downside. If the underlying asset price falls below the strike price, the option holder can almost guarantee that the option writer will buy the asset from the holder at that fixed price.
The premium price depends on the remaining life of the contract, implied volatility (the expected standard deviation of the price of the underlying asset at the beginning and end of the contract), interest rates and the current price of the underlying asset.
The underlying asset’s current price plays an important role in an option’s premium cost.
In the Money (ITM): For call options, the strike price is lower than the underlying asset’s current price. For put options, when the strike price is higher than the current price.
At the money (ATM): For calls and puts, this occurs when the strike price is equal to the current price.
Out of the Money (OTM): For call options, when the strike price is higher than the underlying asset’s current price. For put options, when the strike price is lower than the current price.
How is Crypto Options Trading Different from Traditional Options Trading
The main difference between trading traditional options and crypto options is that the crypto market is open 24 hours a day. In contrast, the traditional financial market is only open Monday to Friday from 9:30 a.m. to 4:00 p.m. Easter time. Crypto markets are also generally more volatile, meaning prices tend to rise and fall more frequently and violently.
The benefit of this high volatility is that traders can earn better returns when the market performs as predicted since there is a larger difference between the strike price and the settlement price at expiry.
Pros of Crypto Options
Besides improving market balance by providing arbitrage opportunities, they also allow users to hedge their risk. They are inexpensive because you do not pay a premium upfront when issuing an options contract. Another hidden advantage is that you do not enforce the option contract.