Market volatility has always been a given in the world of cryptocurrency, but the promise of high returns continues to draw investors to buy and sell cryptocurrency. Against this backdrop, options are growing in popularity as an instrument to help investors weather the bear market. Crypto options trading refers to buying or selling contracts that give the holder the right, but not the obligation, to trade a specific quantity of cryptocurrency at a predetermined price on or before a predetermined date. Before jumping on the bandwagon, as a prudent investor, you may first want to know the advantages crypto options offer that makes them a better investment choice. To answer this, let us first delve into how crypto options are valued.
Factors Affecting the Value of Options in Crypto Trading
The overall value of an option is determined by its intrinsic and extrinsic value.
1. Intrinsic Value
The intrinsic value is the difference between the option's fixed trading price (or strike price) and the current market price of its underlying asset. An option only has an intrinsic value if it is worth something upon expiration. For instance, if the current market value of a cryptocurrency is US$100 and you own an option that allows you to buy the crypto at US$95, your option has an intrinsic value of US$5. This is because you can and will want to acquire your shares at the lower price of US$95 afforded by the option instead of the US$100 market price. On the flip side, if the current market value of the cryptocurrency is US$50, your option will not have an intrinsic value since you will not want to exercise it to buy crypto at a higher price.
Along this same line of thought, if you own an option that allows you to sell crypto at US$105 when the market price is US$100, the option has an intrinsic value of US$5. However, when the asset’s market price rises to US$110, your option will once again lose its intrinsic value.
2. Price of Underlying Asset
The extrinsic value of a crypto option changes over time, and a factor that dictates it is the value of your underlying asset. When the value of your underlying asset rises, the price of call options will similarly increase. This is because call options give investors the right to buy the said asset at a lower price than the prevailing market price and will be in demand under such market conditions. Likewise, a fall in price can cause the price of put options to rise as the demand for these options will rise since they allow investors to gain from selling the said asset at a better price.
Apart from the value of the underlying asset, the extrinsic value of a crypto option is also affected by volatility. Volatility gives you a gauge of the extent to which the price of your underlying asset is expected to fluctuate from now until the expiration of your option. Investors will typically be willing to pay a higher price for an option contract whose underlying asset has greater volatility. The reason is that there is a greater possibility for the asset’s price to be higher than the strike price for a call option or lower than the strike price for a put option upon expiration, and investors can gain from such trading terms.
4. Time to Expiration
Lastly, the extrinsic value of a crypto option is also affected by the time to expiration, and the longer the date to expiration, the higher the option’s value. The logic for this relationship is the same as that used for the volatility component. The more days until the option’s expiration, the more “paths” the price of an underlying asset can take, and the better the trading prospects are for investors.
Pros and Cons of Crypto Options Trading
With an understanding of how crypto options are priced, we can see from the factors above that trading crypto options offers several advantages:
- More strategic alternatives: With crypto options, investors gain the flexibility of trading stock movements and can also take advantage of the passage of time. When employed correctly, traders can benefit from the ability to profit from every type of market.
- Volatility: As part of an option’s price is determined by market volatility, traders can easily capitalize on short-term price movements.
- Liquidity: Crypto options are often more liquid than the underlying assets, which means you can buy or sell them more quickly, enabling you to take better advantage of market conditions.
- Leverage: By allowing the use of leverage, or borrowed funds to trade, options empower you to profit from price movements in the underlying asset without having to commit the full capital required to purchase it.
However, traders should also be wary of the downsides of trading crypto options. For instance, leverage can be a double-edged sword that not only increases your potential profits but your losses as well. Without proper planning, taking a leveraged position for crypto options can be risky.
Trade Crypto Options and More Without Fuss on BIT
With an understanding of how the value of crypto options changes and an evaluation of your investment style and skills, you will be better equipped to gauge if trading crypto options is a good choice. Whether you are looking to include options in your larger portfolio mix or focus solely on this market, BIT can support you in achieving all your investment goals. Built with a cutting-edge unified margin system, BIT’s trading platform facilitates easy control of all your financial instruments under one roof, sparing you the hassle of moving money between different accounts. By allowing investors to trade in their total U.S. dollar holdings and offset losses across various positions, BIT further increases your flexibility to invest. Experience seamless trading and unrivaled simplicity in portfolio management today on BIT.