The article was first published on Finimize.
In part one of our crypto options guide (which you can read here), we covered the theory of options strategies: puts, calls, and all the good stuff in between. But understanding the theory will only get you so far in the real world – and that’s where this second part of our crypto options guide comes in. So if you fancy trading options on a crypto exchange, here’s everything you need to know.
1. How to play the crypto options game
There are two ways to make money with options. The first (covered in part one) is to buy or sell an option and hang onto it until the contract ends. For example, you could buy a call that gives you the option to buy an investment for an upfront strike price sometime in the future. If the actual price is higher than the strike price when that time comes, your call would be “in the money” – meaning you’d get to buy the investment for less than it’s worth. Put options are in the money when you can sell the investment for a higher strike price at the end of the contract.
The second way to profit from crypto options is to trade the options themselves back and forth. You’ll remember from part one that options aren’t free: you’ll need to pay an upfront premium to buy an option. Now, that premium changes all the time. It can be a lot or a little, depending on what the general market thinks the option should cost at any point. As a crypto options trader, your job is to find out where the market might be getting that cost wrong – so you can buy the good deals and sell the bad ones. In other words, you’re trading option premiums, and looking to profit from changes in those premiums as the option gets closer to expiration.
2. So what makes an option premium cheap or expensive?
Options that traders think will be more profitable when they expire tend to cost more (in other words, they have higher premiums). And if you plan to buy or sell an option, there are two questions you can ask yourself to see if it’s a bargain or not:
1. How long until the option contract ends?
All else being equal, an option with more time on the clock has a bigger chance of being in the money at the end of the contract. On the BIT exchange, for example, you could buy or sell options for TON – the token for a blockchain that was originally built by the Telegram messaging platform. So if TON is trading at around $2.20 a token today and you think it’ll go higher, you could buy a call option with a strike price of $3.
Now, if that option expires tomorrow, it’s a lot less likely that TON will be above $3 at the end of the contract. But if it expires in, say, six months, TON has more time on its side to potentially get above $3 – so you’d be willing to pay a higher premium for the call. It’s the same if you were buying a put with a $1.50 strike price: more time means there’s more chance the actual price gets below the strike price by the big day.
2. How likely is it that there’s a lot of volatility around the corner?
Volatile investments move around (in either direction) more than stable ones. So if you buy a call option for a volatile investment (like bitcoin), chances are you’re going to pay more money for it. After all, it means there’s a bigger chance the investment’s price could be in the money at the end of the contract.
Of course, it’s easy to tell whether bitcoin – or any other asset, for that matter – is volatile right now. But it’s a lot harder to predict how volatile bitcoin will be in a week, a month, or even six months from now. Crypto options exchanges (platforms where you can trade crypto options) show the implied volatility (IV) for different options. The IV is simply what the market expects the volatility of bitcoin to be during the life span of the option. All things being equal, when IV is high, the option is more expensive. And when IV is low, the option is cheaper.
3. What are the Greeks?
The Greeks are a set of – you guessed it – Greek letters. Traders can use them to analyze an option and see if they can buy or sell it for a decent premium. Each Greek forms part of a set of equations called the Black-Scholes Options Pricing Model. Those equations are enough to give most folk a headache, and are well beyond the scope of this guide. Still, a basic understanding of a few of the Greeks in isolation (delta, gamma, vega, and theta) will help take your options trading to the next level. If you’re up to the task, you can read all about the Greeks here.
4. A message from BIT
The BIT Portfolio Margin (PM) tool evaluates the risk of a portfolio by calculating the most likely loss a portfolio can incur based on a set of hypothetical market scenarios and a number of parameters set by the risk management team. Compared to the regular margin methodology, which aggregates margin on the individual contract level, the PM methodology tends to reward hedgers by offering a greater margin benefit to their well-maintained low-risk portfolios. For speculators who have directional portfolios, however, a lower margin is not always guaranteed with the PM enabled.
The calculated PM requirement allows for effective risk coverage whilst preserving capital efficiency. The final output of the margin model is used to directly collateralize margin requirements to help insure portfolio positions.
5. Final thoughts
Crypto options come in all shapes and sizes, depending on which exchange you use to trade them. The premiums might be priced in the actual digital asset itself – for example, bitcoin options could be priced in bitcoin, or ether options could be priced in ether. Or the premium could be priced in US dollars, so you’ll make dollar profit or losses depending on how your trade goes.
Options trading takes a bit of time to master. But it’s getting big in the crypto sphere, and you could be well-rewarded in the long run for doing the groundwork now. If you’re okay with the old integers, options can be a good way to speculate on crypto price moves or hedge your current positions. And just as we mentioned in the first guide, you’ll want to practice first on a test trading account until you build enough skills to take things further.
- You can use options to take a bet on where crypto prices go next, or to protect your existing positions.
- Options traders tend to fall into two camps: those who hold them until the contract ends, so they can buy or sell the actual asset for a better price, and those who trade option premiums back and forth.
- When the market thinks an option is more likely to be in the money on the contract expiration date, it usually means the option premium is higher. Your job is to find good deals on those premiums that the market hasn’t caught onto yet.