Gone are the days when crypto trading only meant buying, selling, or HODLing virtual assets in digital wallets. As more crypto exchanges compete for market share, finding innovative and sophisticated financial instruments, tools, and services is getting easier for crypto traders who want to speculate on their favorite digital assets.
For example, crypto options are a trendy financial product for crypto traders, with average monthly volumes regularly between $10 billion and $35 billion for Bitcoin (BTC) contracts alone.
Let’s explore the ins and outs of crypto options trading, including how it works and where to use these products
What is crypto options trading?
Crypto options are contractual agreements where buyers can buy or sell a preset amount of an underlying cryptocurrency by a specific day at a predefined market price (aka strike price). When crypto traders buy or sell options, they exchange paper assets signifying legal rights over cryptocurrencies rather than literal coins like Bitcoin or Ethereum (ETH).
Since options "derive" their value from other assets, they’re part of a category called derivatives, including futures contracts and perpetuals. The critical distinction between crypto options and other crypto derivatives is that the former doesn’t obligate holders to exercise their rights by the expiry date.
For example, if a trader has an option to buy one Bitcoin at a strike price of $25,000, they don’t have to purchase BTC at expiration if they aren’t interested––but they have the option to (hence the name). In contrast, people holding crypto futures contracts––besides perpetuals––must settle their prearranged transactions on the expiration day.
How does crypto options trading work?
Crypto options come with stipulations buyers and sellers agree to fulfill if the buyer exercises their contract before the expiration date, including the cryptocurrency’s quantity a trader has the right to buy or sell at a strike price. There are two options to work with––call and put. A call option allows holders to buy a crypto asset, while put options grant traders the right to sell the digital coin.
To buy a crypto option, traders pay a premium to the seller who writes the contract on an options exchange. Premium prices constantly fluctuate due to dozens of market dynamics, including the underlying cryptocurrency’s current cost, the time until expiration, and the average daily volatility.
Although crypto options contracts generally have expiry dates, traders don’t always have to wait for expiration to exercise (or assign) their contracts. For example, U.S.-style options let traders exercise their contract any time between the day they buy it until the expiry, while European options only give traders the right to buy or sell on expiration day. Some trading platforms settle crypto options with a country’s native fiat currency, but others let traders use digital assets to close their positions.
Benefits and risks of crypto options trading
Crypto options give traders more ways to manage risk in their long-term portfolios and set up fast trades when day or swing trading. Although crypto options offer enhanced customization and flexibility, they come with a few risks.
Crypto options pros
- Risk management and hedging: Crypto options enable traders to preserve their portfolios when they expect bearish momentum and price corrections. Using options strategies, like buying puts or selling calls, helps hedge long-term crypto positions and provides more choices when developing an exit strategy.
- Capital efficiency and leverage: The premiums for options are far cheaper than buying the underlying crypto asset, giving traders greater control over a large market position with relatively little capital in their account. Like other derivatives, expanding an option position’s size with margin trading and leverage makes it easier to amplify profits if the market moves in a favorable direction.
- Income generation potential: Besides portfolio preservation and price speculation, some traders use options strategies to generate consistent income through collecting premiums. Covered calls and cash-secured puts are common ways to create a steady cash flow from an existing long position with options.
- No direct crypto custody: Unless there’s the choice to take a crypto payout after exercising an option, these contracts typically settle in cash. For traders uncomfortable with securing their digital assets, options offer a simple way to get crypto price exposure without worrying about hacks or learning the intricacies of transferring virtual coins.
Crypto options cons
- Time-sensitive strategy: Since options have expiration dates, they give traders a narrow window of opportunity to accurately predict a crypto asset’s price movement. Traders used to the open-ended time horizon of strategies like HODL and dollar-cost averaging (DCA) need to feel confident with options’ time pressure on portfolios.
- Assignment risk for sellers: Unlike buyers, options sellers should fulfill their end of the agreement if the buyer exercises their rights. If an option seller isn’t prepared for assignment, they risk losing capital or going into debt to meet their obligations.
- Counterparty risk for buyers: Options buyers rely on sellers to fulfill their commitments whenever they choose to exercise a contract, exposing them to counterparty risk. Also, when traders use a centralized crypto exchange (CEX), they have to rely on an intermediary’s security and legitimacy to process transactions.
- Liquidity concerns: Bitcoin options trading is on the rise, but the market for these derivatives remains concentrated on a few trading platforms like Deribit and OKX. Until crypto options become more widely accessible and popular, traders may have difficulty finding enough liquidity to seamlessly swap contracts, especially for low market cap altcoin projects.
Popular crypto options trading strategies
Countless complex trading techniques are associated with crypto options, thanks to the latter’s exceptional versatility. While some options strategies are quite advanced, a few straightforward tactics offer beginner options traders many potential benefits. Here’s a quick guide on how to trade these crypto options:
Covered call
In this conservative strategy, crypto traders sell a call option for a coin they already hold in their portfolio. For example, if a trader has 0.5 BTC, they write a call for 0.5 BTC with a strike price of $25,000 per coin.
Traders often use covered calls to collect steady income from premiums when they don’t expect crypto prices to rise. Remember, the trader who writes a call must sell their crypto collateral at the agreed price if the option buyer exercises their contract.
Protective put
Think of protective puts as buying insurance on a long-term crypto position. Traders using this strategy buy puts for a crypto asset in their portfolio if they believe it’ll drop in value before the contract’s expiration. This way, even if a cryptocurrency’s market price falls, traders profit from price appreciation for their put contract.
Long straddle
Long straddles involve simultaneously buying both call and put options with the same strike price and expiration date. Traders typically use this strategy when they expect the underlying cryptocurrency’s price to move far outside its current range but aren’t sure whether it’s headed up or down.
Long call spread
Traders buy and sell call options with the same expiration date but sell the option at a higher strike price than the one they buy. This strategy is also called a bull call spread because the premium for the option a trader buys rises as the cryptocurrency’s price approaches the second option’s strike price.
Long put spread
Also called the bear put spread, long put spreads are the inverse of long calls and only rise in value if the cryptocurrency’s price falls. Here, traders buy a put option and sell another one at a lower price with the same expiration date, hoping a crypto asset falls to the second contract’s strike.
Eligible traders can discover crypto perpetuals trading on dYdX
Perpetuals differ from option contracts but are another hot product for setting up crypto trading strategies. Although perpetuals are technically futures contracts, they don’t have an expiry date, which gives traders extra flexibility to open and close positions.
To find out more about how perpetuals differ from other trading vehicles, check out dYdX Academy for more in-depth trading guides. Also, don’t forget dYdX offers eligible traders a decentralized trading experience with deep liquidity for Bitcoin and altcoin perpetuals. Head to dYdX’s official blog for more details on our latest updates, features, and products, and eligible traders can start trading on dYdX today.
Disclosures
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