Bitcoin options trading allows investors to hedge their portfolios or speculate on future price movements. By studying how Bitcoin options work and understanding bitcoin indicators, traders can make more informed decisions when buying, selling, or exercising their options. This article will teach you how to trade Bitcoin options and cover effective strategies to maximize profits while minimizing risk.
Bitcoin Magazine Pro's Bitcoin analysis is valuable for achieving objectives, such as confidently trading Bitcoin options using effective strategies that maximize profits while minimizing risks. Studying Bitcoin's price fluctuations and market trends before trading options can help you make informed decisions.
What are Bitcoin Options?
Bitcoin options are a popular financial derivative in major asset classes. Since January 2020, they’ve been available for Bitcoin, too. Options give holders the right, but not an obligation, to buy BTC at a predetermined price at a certain point in the future.
A primary advantage of Bitcoin options is enabling traders to hedge their bets in a volatile market. They could make a profit even if prices fall. There are two main types of Bitcoin options:
- Call option: Allows traders to buy BTC at a fixed price.
- Put option: Enables them to sell BTC at a fixed price.
Beyond that, there are three other important metrics to consider:
- Strike price: Refers to the rate when a contract can be exercised.
- Expiration date: When the contract terminates. Options can have varying time frames depending on the investor’s needs.
- Premium: Cost of agreeing in the first place.
Riding the Bull: 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 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 agree with the seller to allow you to purchase the land at a particular price and mandate the seller to sell it all for a small fee (premium).
- Would you accept the offer? Most probably. This same logic applies to Bitcoin call options.
The agreement 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, you can forfeit it and lose the premium paid.
Hedging Your Bets: 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, when an investor thinks the price of Bitcoin will decline rapidly or is bound to do so over a specific time frame.
This contract becomes valuable whenever the actual Bitcoin price falls below the strike price before or on the expiration date. The holder can 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. 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, the price of fruits decreases. 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 paid premium.
It's worth noting that Mr. Stone decides the premium paid based on the perceived demand for his fruit at that time. The same logic applies to Bitcoin put options.
How Bitcoin Options Trading Works
Bitcoin options are contracts that give holders the right, but not the obligation, to buy or sell Bitcoin at a predetermined price by a specified date. They’re popular among investors because they can be used to hedge against price fluctuations in the underlying asset or speculate on future price movement.
How to Trade Bitcoin Options
Trading Bitcoin options is relatively straightforward.
- You’ll need to choose a Bitcoin options trading platform or exchange that lists options contracts on Bitcoin.
- You must fund your account and navigate to the platform’s options section.
- You can view the available contracts organized by expiration date. Select a contract to view its details, including the strike prices, how much you’ll pay in premiums, and other important information.
- After you buy or sell a Bitcoin options contract, you can hold it until expiration, at which point you can exercise the contract or let it expire worthless.
What’s the Role of Premium Payments?
Every trader must understand the premium, a key component in options trading. The premium is the price that traders pay to buy options contracts. It’s essentially a fee to execute an options contract. The premium is determined by several factors, including market conditions, the underlying asset's volatility, and the amount of time left until expiration.
The more volatile an asset is, the higher the premium. This is because there’s a greater chance that the options contract will end up in the money or be profitable before expiration. As expiration approaches, premiums will decrease. This is known as time decay and can impact the profitability of options trades. The longer you hold an options contract, the more likely the trade will become profitable. As expiration approaches, the time value of the contract decreases, which can impact your overall profitability.
How to Calculate Options Profit and Loss
Calculating your profit and loss on Bitcoin options trades can be complicated, especially for new traders. If you buy a call option, you’ll begin to make a profit once the price of Bitcoin exceeds the strike price plus the premium you paid for the contract. If you buy a put option, you’ll start to turn a profit once the price of Bitcoin falls below the strike price minus the premium. To illustrate:
Imagine Ellen taking out a Bitcoin call option, allowing her to buy BTC for $55,000 at any point in the next three months. She pays a $1,200 premium for the contract. In this scenario, BTC surges to $70,000 within that time frame. The nature of this options contract means Ellen could buy this for substantially less than its market value. After the premium is deducted, she’d be left with a profit of $13,800.
Now let’s look at Paul, who’s purchased a put option. He enters into a contract that gives him the right to sell Bitcoin for $50,000 in the next 90 days. A sudden market downturn means BTC ends up tumbling to $40,000. The nature of this agreement means he’d be able to offload for more than it’s worth at current rates, delivering gains. It’s worth making a quick distinction between American and European options. In the U.S., options can be executed whenever the holder pleases. However, in the EU, these financial derivatives are only activated on the final day of the contract, resulting in a greater level of risk for holders.
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Why are Options on Bitcoin Popular?
Flexibility of Bitcoin Options: The Ability to Adapt to Market Movement
Purchasing Bitcoin on the spot market can be a risky move for traders with a short-term outlook. Wild price swings in either direction can happen at any time, and a profit can only be made if this rises in value.
By contrast, these derivatives offer greater flexibility while limiting a trader's risk. If a call or put option doesn’t pay off and the market moves in the opposite direction to what was desired, these contracts can expire worthless, meaning that losses are limited to the premium that was initially paid.
Hedging: Protecting Your Bitcoin Investment
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 landowner 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 underlying asset's value, in this case, Bitcoin, by locking its value, i.e., the price at which Bitcoin can be traded for money.
Price Speculation: Predicting Bitcoin Price Movement
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 when you feel a bearish run is imminent in the upcoming months? Although the underlying asset's price may bounce back after a while, purchasing a put option would maximize your chance to make some profit.
The Benefit of Leverage: A Small Investment for Big Gains
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 worth $20,000 or more.
Expiration Dates: Understanding the Basics of Options Contracts
Expiration dates refer to the agreed date on which the contract option, either buying or selling, will be exercised. Note that not every Bitcoin options contract can only be fulfilled on its expiration date; some can be exercised before the expiration date. Below, let's look at the two methods of contract fulfillment.
1. European-Style Options Contracts: The Basics
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 this time, major Bitcoin options trading platforms offer only European-style contracts.
2. American-Style Options Contracts: More Flexibility for Traders
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, 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 at any time between the date entered and the expiration date.
OTM vs. ITM vs. ATM: Understanding Bitcoin Options Trading Terminology
OTM, ITM, and ATM are frequently discussed in options trading. Although they share fundamental similarities, they function differently in diverse scenarios. These terms describe the relationship between the current Bitcoin price and the strike price of an option.
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-the-money (ITM)
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.
At-the-money (ATM)
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 trades at around $31,000, the put option is ATM.
Based on market predictions, the option holder must decide whether it would be beneficial to exercise the option. Depending upon their contract, traders can utilize these contracts to hedge against market unpredictability.
Holding and Writing Bitcoin Options
Hodling (buying) and writing (selling) Bitcoin options differ in two key ways:
- Risk
- Reward
When you buy an option, you pay a premium for the right to buy or sell Bitcoin at a specific price before the option expires.
When you sell an option, you receive the premium in exchange for taking on the obligation to fulfill the contract if the holder decides to exercise their right. Writing Bitcoin options is like playing defense while buying options is like playing offense. Both strategies can make money, but they do so in different ways and come with other risks.
How Do Bitcoin Options Work?
To understand the differences between holding and writing Bitcoin options, it helps to know how Bitcoin options work. When you buy an option, you pay a premium for the right to buy or sell Bitcoin at a specific price before the option expires. You lose the premium if the option expires and you don’t exercise your right. In this way, Bitcoin options work like insurance policies. If the market moves in your favor, you can profit by exercising the option or selling it for a premium to another investor.
Writing Bitcoin options is the opposite of hodling. When you write an option, you receive the premium from the holder and take on the obligation to fulfill the contract if the holder exercises their right. The risk of writing options is that you may have to sell Bitcoin at a loss or buy Bitcoin at a higher price than the current market value. Both strategies can make money, but they do so in different ways and come with different risks.
The Greeks
Options contracts are complex financial instruments with unique pricing structures that can change as market conditions fluctuate. To understand the factors responsible for an option's price in Bitcoin options trading, it's essential to know the Greeks. Named for letters in the Greek alphabet, the five members of the Greeks include:
- Delta
- Gamma
- Theta
- Vega
- Rho
Each of the Greeks measures a different aspect of an option’s price. They help investors make informed decisions about trading Bitcoin options, whether they’re hodling or writing contracts. For example, let's say you want to buy a Bitcoin option. Knowing the Greeks can help you understand how much you might pay to open the contract as a holder. If you write the option instead, they’ll inform you how much you’ll receive to sell the contract as a writer. Understanding the Greeks can also help you manage your risk as market conditions change.
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How to Trade Bitcoin Options
1. Picking a Trading Platform for Bitcoin Options
Bitcoin options trading can be available on traditional derivatives platforms, offering exposure to other assets, like stocks or gold. Investors may start Bitcoin options trading on a familiar platform or open a new account on a reputable platform or exchange known for its robust trading features.
2. Getting Started with Your Chosen Platform
Once you have chosen a platform, you must sign up and complete any necessary verification processes required by the chosen platform. Many exchanges require users to verify their identities before trading to help prevent money laundering and fraud.
3. Fund Your Account
Once you have completed any necessary verification steps, deposit funds in Bitcoin; depending on the platform’s requirements, some exchanges only allow deposits, while others accept deposits in U.S. dollars.
4. Find the Options Section and Learn the Interface
Before executing a trade, locate the derivatives or options section on the platform and familiarize yourself with the interface and the types of options contracts available.
5. Pick Your Options Contract
Next, choose a call or put option based on trading strategy, market analysis, and understanding of options contracts, considering fundamentals like:
- Strike price
- Expiry date
- Premium
6. Execute the Trade
It’s time to execute the trade. Enter the details of your trade, such as the contract size (number of options) and the price you’re willing to pay. Review and confirm your order.
7. Monitor Your Position
To stay informed after executing your trade, monitor Bitcoin, the contract, or the position.
8. Close or Exercise Your Position
Decide whether to exercise the option (if ITM and it’s an American option), hold it until expiry, or sell the option contract before expiry to close your position, depending on market conditions and your strategy.
Risks to Watch for When Trading Bitcoin Options
Before you begin, know that trading options involve a high level of risk. If you are new to Bitcoin derivatives trading, you should start with a demo account to learn the ins and outs of options trading before putting investment capital at risk. Remember that Bitcoin is not regulated as a security but is considered a digital currency.
Options are Riskier Than Spot Trading
Trading Bitcoin options are generally riskier than buying and selling Bitcoin in the spot market. For example, suppose you buy a call option on Bitcoin with a strike price of $35,000 and an expiry date three months away. If the price of Bitcoin doesn’t surpass $35,000 by the expiration date, you will lose the options premium (the price you paid for the option) in full.
Options are More Complex Than Spot Trading
When trading Bitcoin options, the price is not the only factor affecting the value of options contracts. Several key factors affect the value of the options you buy or sell, but time decay is the most critical. That’s because as the time moves closer to the expiry date, the value of an options contract decreases. After all, the time remaining to trade or exercise the options diminishes.
The Bitcoin Options Market is Less Established
While Bitcoin options can be found on traditional securities exchanges, like the Chicago Mercantile Exchange (CME), and on dedicated trading platforms, the BTC options market is still quite young and doesn’t have the deep liquidity found in mature options markets. This can affect price slippage, especially in options with longer maturities.
Factors to Consider When Opening an Options Trading Account
Security First: Why You Need a Reputable Derivatives Exchange
When trading Bitcoin options, security should be your top priority. Pick a reputable derivatives exchange that boasts a high level of security, highlighted by a track record of no hacks. Hacks and exploits are all too common. Reputable exchanges have proven security measures that keep customer funds safe, even during turbulent market conditions.
Don’t Get Caught by Fees
Trading fees can affect your trading profitability, especially when you are an active trader on an exchange with high commissions. Choosing a Bitcoin derivatives trading platform that balances low fees with platform reliability, strong trading technology, and highly rated customer service is essential.
Research Tools
If you plan on trading Bitcoin options, you should use a platform with all the tools you need to set yourself up for success. Ideally, the trading platform should offer a range of charting tools and options calculators and highlight all aspects of each contract in a clear, easy-to-understand manner.
Storage and Custody
Choose a trading platform that holds most, if not all, customer funds in cold storage. That greatly reduces the chances of losing funds due to an exchange hack.
If the exchange has additional wallet security features in place, such as withdrawal address whitelisting, that’s even better. Address whitelisting is a popular exchange wallet security feature that only allows withdrawals to specific whitelisted external wallet addresses predetermined by the user.
Customer Service
You should also choose an exchange with responsive, high-quality customer support. After all, it’s your money at stake, so if there are any issues with the platform, you need to be able to resolve them quickly with the help of the exchange’s support team.
Bitcoin Options vs. Bitcoin Spot Trading vs. Bitcoin Derivatives
Bitcoin Options: A Flexible Approach to Trading
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: The Most Straightforward Method to Buy Bitcoin
Traders in spot trading prefer to buy or sell actual Bitcoin on exchanges at the current market price, with settlement and ownership taking place immediately. Unlike options or futures trading, the spot market allows traders to own the underlying asset directly 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: A High-Risk, High-Reward Trading Strategy
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.
Derivatives enable traders to speculate on Bitcoin's price without owning the asset. They offer leverage, allowing traders to control larger positions with less 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 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 experience and a deeper understanding of the market, they may explore Bitcoin options as a risk management tool or take advantage of specific price scenarios. Intermediate traders should exercise caution when considering Bitcoin derivatives due to their higher risk and complexity.
Derivative trading can amplify profits and losses, making it more suitable for experienced traders with a solid grasp of risk management strategies. 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.
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Are Bitcoin Options a Good Investment?
To Bitcoin miners, options can keep their rewards at reasonable levels when implemented carefully, but when the price of Bitcoin drops, the miners' reward (denominated in Bitcoin) falls. This puts pressure on operations and can increase the likelihood of a miner shutting down.
Bitcoin options can help miners stabilize their revenue and reduce the risks associated with falling prices. They allow miners to lock in prices for future contracts, ensuring they can continue operating even if the market deteriorates.
A Hedge for Investors
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. If you think Bitcoin is headed for a downturn, you can buy options to profit from the drop.
If you think Bitcoin is nearing a bottom and will eventually recover, you can buy put options to hedge your position and offset potential losses. As Bitcoin recovers, your possibilities will gain value, and you can sell them for a profit without ever having to sell your Bitcoin.
A Way to Get Your Feet Wet
For the investor who wants a feel of the market without prior experience with Bitcoin, there’s an option for you in the form of Bitcoin options contracts. These derivatives allow you to speculate on the future price of Bitcoin without having to buy the underlying asset.
They also have fewer risks than buying Bitcoin directly in a bear market. If you’re looking for a way to get your feet wet in the Bitcoin market, options are a good place to start.
Editor’s note: Please ensure you know the risks involved. Only trade options if you’re comfortable stomaching the level of risk.
The Best of Both Worlds
If you’re looking to profit from volatility in the Bitcoin market without the risks of directly holding the asset, Bitcoin options are a great way to do it. Options allow you to speculate on the future price of Bitcoin and profit from both rising and falling markets.
They can also help miners stabilize revenue and hedge against falling prices. If you’re new to Bitcoin, options can help you understand the market without buying the underlying asset.
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