Bitcoin options: speculation and risk management
A little more than a decade has passed since the birth of Bitcoin. Since then, it has completely changed how the world sees digital currencies. Once snubbed by the world in general as nothing more than a niche that only the most computer experts and technophiles would prefer, Bitcoin is now traded for speculation, exchanged, and used as a medium of money in nearly every corner of the world.
Initially, there were only a few online exchanges that offered very simplified forms of trading for people who were interested in Bitcoin. As the years have progressed, hundreds of thousands of people (or maybe millions) have started trading cryptocurrencies. With the exponential rise in the demand of Bitcoin, new ways and methods it can now be traded have also emerged.
Bitcoin Options concept is a complete copy of the traditional options trading. A type of derivative trading, Options, allows the trader to buy or sell Bitcoin at a pre-defined price at the expiry time of the contract. This gives the investor or trader the right to trade but does not force the obligation to make the trade, hence it is called a Bitcoin Option.
For many people, the concept of Bitcoin Option seems very complicated, with a perception that this has been created for the most shrewd and talented financial traders that can be found in the likes of Wall Street and other global financial hubs. However, Option trading is not a new concept, with its roots dating as far back as ancient Greece, where traders would speculate on the harvest of olives. It is a multicultural phenomenon found in many other countries, such as the Japanese Dojima Rice Exchange. In every option trade, just like any other, there are two parties involved: the Holder and the Writer. Do not let the names confuse you. The Holder is the buyer, and the writer is the seller of the contract. The buyer is called the Holder since the trader withholds the option to buy or sell the Bitcoin. As a writer, you essentially give away your right to decide to buy or sell Bitcoin.
Put and Call Options
In this article, the risk nature of options trading is explained from the buyers’ side (put option buyer, call option buyer). A call option gives the Holder the right to buy, and a put option gives the right to sell a specific number of shares of the underlying stock at a particular price by a predetermined date. So the risk is only limited to a premium (contract price) that you have to spend to become a holder of a contract.
Conversely, if you are willing to sell a put or call option, then the risk/reward profile has a slightly different model. A seller of a call option is obliged to sell a specific number of shares of the underlying stock at a predetermined price. Whereas, a seller of a put option is required to buy a particular amount of stock at a predetermined price.
Now that you know about the buyer/seller concept of Bitcoin Options, let us look at how the options contracts are executed and how to make a profit.
A Put option is made when a trader predicts that there will be a price fall of Bitcoin and hence a trader obtains the right to sell the defined quantity of Bitcoin in the options contract with a higher price at the expiration time. The right is not obligatory and can be withdrawn. If the trader has made correct assumptions and the Bitcoin price eventually falls, he or she can now sell the Bitcoins at a higher price, thus creating a profit. The amount of benefit depends on the quantity of Bitcoin and the difference between the strike price and the current market price.
Alternatively, a trader can go for a Call option if he/she predicts that the price rises from the current level. After the contract is executed and if the price surges, the trader makes a profit by obtaining the BTC at a lower price, which is pre-defined in the contract (strike price).
Popular options trading platforms like Deribit have implemented a cash-settled option feature for which actual physical delivery of Bitcoin is not required. Instead, at expiry, the writer (seller) of the options contract will
Speculations and Hedging
One of the most significant advantages of Bitcoin Options trading is that investors can tap into the profit potential without taking many risks compared with buying the underlying bitcoin. In options trading, investors and traders pay a premium when trading. Notice that in both put and call options, the trader is not obliged? To buy or sell the contract at the time of expiry. As a trader, if you see that you will potentially be making profits as the price is successfully moving in the direction you predicted, you can already sell the contract in profit. A technical indicator study of trading graphs and price history will help you make a sound judgment on the future speculations. Should your experience and the signals indicate that there will be a rise or a fall in Bitcoin price with reasonable surety, you can go for put or call options.
Since options trading is not obligatory and can be called off at any time before the expiry, traders can use put options to minimize their losses in case of a price fall.
Leading By Volume Options Crypto Exchanges
According to the market analyst website Skew, Deribit leads the race in terms of Bitcoin Options volume traded, followed by CME. On June 9th Deribit traded $120 million in options, with CME trading $61 million.
When we look at the Bitcoin options weakly interest, data reveals that there is significant liquidity. Open interest in options trading stands for the total sum of all options contracts that have not expired, been exercised by holders, or physically delivered. Accumulating public interest is an indicator of a maturing market in which the number of market participants joining the crypto market for speculative and hedging purposes is rising.
Written by Dmitri Perepelkin