As an investor interested in expanding to new asset classes like cryptocurrencies, you may be considering crypto options as a way to manage risk. With proper education, crypto options can be a powerful tool for optimizing your portfolio. This guide covers the basics of options, how they work in crypto markets, and strategies to help determine if options trading is right for you. We’ll walk through core concepts like strike prices, expiration dates, and basic bullish/bearish trades. You’ll learn how options on Bitcoin and Ethereum work compared to traditional markets. By the end, you’ll have key information to decide if crypto options fit your investing style and risk tolerance. Let’s get started.
What Are Crypto Options?
Crypto options are financial contracts that give the buyer the right, but not the obligation, to buy or sell a cryptocurrency at a predetermined price within a certain time period.
How Do Crypto Options Work?
Crypto options allow traders to speculate on the price of cryptocurrencies. The options contract specifies the expiry date and strike price. The strike price is the price at which the underlying crypto can be bought or sold.
If the price of the underlying crypto is above the strike price at expiry, call options are “in the money” and put options are “out of the money.” Conversely, if the price is below the strike price, put options are in the money and call options are out of the money. In the money options have intrinsic value and can be exercised for a profit.
Traders pay an upfront premium to buy options contracts. The premium depends on the strike price, expiration date, and the price of the underlying crypto. If the option expires out of the money, the premium is lost. But if the option expires in the money, the profit potential is high.
Why Trade Crypto Options?
Options allow traders to speculate on the price of cryptocurrencies with leverage. Options also provide an opportunity to hedge positions in the underlying crypto. For example, if you own Bitcoin, you can buy put options to protect against downside risk. Options trading does come with risks, so you need to understand the complex strategies involved before getting started.
How Does Crypto Options Trading Work?
Crypto options trading allows investors to speculate on the price movement of cryptocurrencies. An options contract gives the buyer the right, but not the obligation, to buy or sell an underlying crypto asset at a specific price on or before a certain date.
Buying Call Options
A call option gives the buyer the right to buy the underlying crypto at a specified price within a certain time period. For example, if you believe the price of Bitcoin will rise in the next month, you can buy a call option that allows you to buy Bitcoin at today’s price in one month’s time. If the price of Bitcoin does rise, you can exercise your option and buy it at the lower call option price, making an instant profit.
Selling Put Options
A put option gives the buyer the right to sell the underlying crypto at a specified price within a certain time period. For example, if you believe the price of Ethereum will fall in the next three months, you can buy a put option that allows you to sell Ethereum at today’s price in three months’ time. If the price of Ethereum does drop, you can buy it at the lower market price and sell it at the higher put option price, making a profit.
To trade crypto options, you need to go through a broker that offers this service. You will have to pay a premium upfront for the option contract, which depends on factors like the crypto price, strike price, time to expiration, and volatility. Options trading allows you to potentially profit whether crypto markets are bullish or bearish. However, options also come with risks like time decay, volatility, and leverage. You can lose your entire investment, so only trade options if you fully understand the risks.
Crypto Options vs Futures: Key Differences
Crypto options and futures are two common ways to trade cryptocurrencies. While they share some similarities, there are several key differences to understand before trading either.
Contract Specifications
Options contracts give you the right, but not the obligation, to buy or sell an underlying asset at a specific price within a certain time period. Futures represent an obligation to buy or sell an asset at a predetermined price on a specific date. Options provide more flexibility, as you can choose whether or not to exercise the contract. Futures require you to buy or sell at expiration.
Leverage and Risk
Options and futures both provide leverage, allowing you to control a large position with a small amount of capital. However, options typically have a lower risk since you can walk away from a trade if it moves against you. Futures require you to settle the trade at expiration, even at a loss. Options risk is also limited to the premium paid, while futures positions have potentially unlimited risk.
Expiration and Settlement
Cryptocurrency options have expiration dates, typically weekly, monthly or quarterly. At expiration, options either expire worthless or are automatically exercised if in the money. Futures also have expiration dates, at which point the contract must be settled by buying or selling the underlying asset. Options settlement results in the transfer of the actual crypto, while futures are often settled in cash.
Trading Strategies
Options provide more strategic alternatives for traders. You can use options for speculation, hedging, or generating income. Options spreads, straddles, and strangles are more complex strategies used by advanced traders. Futures are primarily used for speculation and hedging. They do not lend themselves as well to income generation or complex trading strategies.
In summary, while crypto options and futures share some characteristics, key differences in their contract specifications, leverage, risk, expiration, and available trading strategies set them apart. Understanding these differences will help you determine which product is the right tool for your trading objectives.
Strategies for Crypto Options Trading
As crypto options trading gains popularity, several strategies have emerged to help investors maximize profits and minimize risks. Familiarizing yourself with these strategies is key to successful trading.
Buying Calls
One of the most common strategies is buying call options. This allows you to control 100 shares of the underlying crypto for a fraction of the cost. If the price rises significantly, the value of your options also rises, allowing you to sell at a profit. You can also exercise the option to buy the crypto at the strike price. This strategy is ideal if you believe the crypto’s price will increase.
Selling Puts
Selling or “writing” put options is a strategy used when you expect a crypto’s price to remain steady or rise. By selling puts, you collect a premium from the buyer. If the price stays above the strike price, the options expire worthless and you keep the premium. However, if the price drops below the strike, you are obligated to buy the crypto at the strike price. This strategy generates income but also introduces risk.
Spreads
Spread strategies, like bull call spreads and bear put spreads, allow you to offset costs while still benefiting from price movements. For example, a bull call spread involves buying a call option with a lower strike price and selling a call option with a higher strike price. This generates income to offset your costs but still allows you to profit if the price rises above the lower strike. Spreads cap your profit potential but reduce risks compared to simply buying calls.
Straddles
Straddles involve buying both a call and a put option with the same strike price and expiration. This strategy profits when there are large price swings in either direction. You profit from the option that gains value, offsetting the loss from the other option. Straddles allow you to take a neutral approach while still benefiting from volatility. However, without significant price movement, both options may expire worthless.
Carefully evaluating these strategies based on your risk tolerance and market outlook can help determine which approach aligns with your trading goals. With the high volatility of the crypto market, options trading provides an opportunity for significant profits, but you must go in prepared.
Getting Started With Crypto Options Trading in India
Crypto options trading allows investors to speculate on the price of cryptocurrencies like Bitcoin without directly buying the underlying crypto asset. Options give you the right to buy or sell the underlying crypto at a specific price within a certain time period.
Understanding Call and Put Options
The two major types of options are calls and puts. A call option gives you the right to buy the underlying crypto at a predetermined price, called the strike price, before the expiration date. If the price of the crypto rises above the strike price, the call option can be exercised for a profit. A put option gives you the right to sell the underlying crypto at the strike price before expiration. Put options become more valuable as the crypto price falls below the strike price.
Selecting a Brokerage
To trade crypto options, you will need to open an account with a broker that offers crypto options trading. Some traditional online brokerages like E*Trade and TD Ameritrade offer bitcoin futures trading but not crypto options. Cryptocurrency exchanges like Deribit, Quedex, and LedgerX are currently the only platforms that offer crypto options trading. These exchanges operate globally but have different rules for customers in India. Do thorough research to find an exchange that meets your specific needs.
Funding Your Account
Once you have selected a brokerage, you will need to fund your account to start trading options. Most crypto exchanges only accept deposits of major cryptocurrencies like Bitcoin, Ethereum or stablecoins. You will first need to purchase crypto from an exchange like Zebpay, CoinDCX or WazirX, which allow INR deposits, then transfer your crypto to your options trading account. Be aware of fees for crypto transfers between exchanges.
Placing Your First Trade
When you are ready to place your first crypto options trade, you will need to decide if you want to buy a call or put option. Then you must determine the underlying crypto, strike price and expiration date. Start with small trades to minimize risk as you learn. Crypto options trading can be very lucrative but also risky. With practice and experience, you can build winning trading strategies. But never invest more than you can afford to lose.
Conclusion
In closing, you now have a foundational understanding of crypto options trading. By learning the basics, assessing your risk tolerance, choosing a trading platform, and implementing sound strategies, you can start trading crypto options. With practice, study, and prudent decisions, you may steadily gain proficiency. Crypto options provide opportunities, but also risks. Stay patient, keep emotions in check, and stick to your plan. You’re now equipped to begin your crypto options trading journey. With dedication and discipline, you can work toward your financial goals through this new asset class.
