Everywhere you turn in financial sector, the focus is on Bitcoin and cryptocurrencies. Businesses are now adopting blockchain or supporting digital currency for payments. Many more are buying BTC and other coins to replace treasury cash reserves. The largest segment is investing in, or trading Bitcoin.
But because that segment is so vast, investing, and even more so trading, can take on all sizes, shapes, and forms. Investing simply involves BTC holding for the long-term. The most prominent example of Bitcoin trading involves buy and sell orders back and forth called spot trading. More advanced methods of trading include derivatives, which consist of futures, CFDs, and options.
In this guide, we’re looking at financial derivative products, specifically, Bitcoin options and how they compare to other derivatives trading instruments such as Bitcoin futures, and Bitcoin CFDs. Here’s everything you need to know about trading the largest cryptocurrency by market capitalization, specifically trading options on Bitcoin.
What Are Options? The Basics Of Options Trading
Options are a form of financial derivative trading instrument that traders can leverage to make additional profits, or hedge against spot investment positions. Options are derivatives contracts that provide traders with the right, but not obligation to buy or sell the contract at or before an expiration date.
This type of options trading is considered a relatively low risk, high reward way to trade. However, unlike futures trading and or CFDs, there is a large up front cost called a premium. Binary options are a yes or no type situation, where the trader either receives an all or nothing profit for the premium fee to enter the contract.
Bitcoin options work very similar to traditional options, but instead speculate on the future market price of Bitcoin instead of other assets. Here is an explanation of the various aspects of Bitcoin options trading.
Holding And Writing Options
Because these derivatives products are contracts, the terminology used around trading Bitcoin options is also unique. Although the same terms are also prominent in stock market options trading. For example, an options holder is a buyer of the contract, while a seller is referred to as a writer. Depending on if the trader wants to buy or sell will determine if they are write or hold an option.
- Bitcoin Call Options. A call option in Bitcoin is a contract that gives the option buyer or holder the right, but not the obligation, to buy Bitcoin as a specified price.
- Bitcoin Put Options. A put option in BItcoin is the opposite – a contract that gives the option seller or writer the right, but not the obligation, to sell Bitcoin as a specified price.
- The Greeks. Various Greek alphabet letters are used to “provide a way to measure the sensitivity of an option’s price to quantifiable factors,” and include delta, gamma, vega, and theta according to Investopedia.
Because of the terminology unique to Bitcoin options trading, it can seem confusing at first. However, the Greeks represent very simple methodology that can is easy to remember once explained properly.
- Delta is the total amount the option’s current price is expected to move based on a $1 change in Bitcoin, in essence measuring the sensitivity of an option’s theoretical value versus the change in the price of Bitcoin. Call options have a positive delta while put options have a negative delta.
- Gamma measures the rate of change in the delta for each one-tick increase in Bitcoin. It helps forecast changes in the delta of an option contract. Gamma is positive for both put and call options.
- Theta is extremely important to understanding the impact of time on options premiums. It essentially measures the dollar amount or BTC amount a Bitcoin option will lose each day as time passes by.
- Finally, vega measures the sensitivity of the price of Bitcoin options in relation to the notorious price volatility the asset class is known for.
How Do Bitcoin Options Work?
Bitcoin options can work one of two ways: settled in cash, or settled in BTC. Those who buy Bitcoin options or sell contracts, should pay attention to how the contracts are settled. Options holders or writers have the option, but not the obligation, to buy or sell Bitcoin at or before the time the contact expires, called the expiry. The amount of profit depends on a variety of factors, including the premium, the market value and average price of Bitcoin, and more.
The strike price is the price option holders or writers can buy or sell the contract at. Two types of options exist, American and European. American options allow traders to buy or sell the options contract before an expiry date, while European options contracts allow execution only on the day the contract expires.
Why Are Bitcoin Options So Expensive?
In options trading, trader are exposed not just to the price of an asset but market volatility. The more volatility the higher the risk premium can be. When premiums get exorbitantly it can limit the profit by cutting into potential margins. Current market conditions in crypto are highly volatile, making options contracts especially expensive recently.
Bitcoin Options Vs Bitcoin CFDs: Which Is Best?
Bitcoin options trading is a popular and growing category of crypto derivatives contracts. Another quickly emerging category are CFDs. CFD stands for contracts for difference, and are derivatives contracts that let traders hedge short or go long on various trading instruments. The contract is settled at the difference in market price from the time the position was opened until it was closed.
Here’s how the two very different types of Bitcoin derivatives contracts differ and compare, as well as any pros and cons.
Bitcoin CFDs
Bitcoin CFDs can be interpreted in two ways. It can reference when Bitcoin or BTC is used as the collateral asset, as in “Bitcoin-based CFDs.” The CFD itself, however, even if based in, and settled in BTC, can represent any trading pair or instruments – for example, stock indices, commodities, forex, and other types of cryptocurrencies.
CFDs let traders long and short markets, and easily get in and out of positions without the need to worry about expiration dates or time. There’s also no Greek letters to pay attention to. Instead, there’s easy to understand tools such as stop loss, limit, and market orders.
CFDs can also lead to exotic trading pairs or instruments, as well as the ability to easily get in and out of positions unlike other types of derivatives contracts like options or futures. Volatility can be managed effectively with stop loss tools. CFDs can also apply things like leverage using margin accounts that enhance profitability. However, there is considerable risk involved with leverage.
Pros
- Low fees
- Suited for day trading and scalp positions or swing trades
- Exotic trading instruments
- CFD trading basics are easy to understand
- Rapid position entry and exit
Cons
- Moderate risk is involved in CFD trading
- Not allowed in all jurisdtictions – check with local laws for restrictions
- Skill is required to become profitable
Bitcoin Options
Bitcoin options have been thoroughly explained throughout the article, but as a brief recap, it is a derivatives contract that gives a holders or writer the options to buy or sell Bitcoin at a specific price on or before an expiration date called an expiry.
Traders pay a premium to make a low-risk bet that the price outcome will be what they expect, allowing the trader to profit from the price difference in the options contract.
Pros
- Option strategies are considered relatively low risk
- Depth for advanced traders
- Is yet another derivatives contract for traders to consider
Cons
- Low rewards due to low risk involved
- Complicated Greek system
- Due to the complexity of options, it is challenging to place large scale orders
- Average price volatility in Bitcoin makes options contracts expensive
Bitcoin options, while expensive, still offer several benefits for traders. These include hedge positions, detailed options strategies, and more.
Disadvantages include the complex Greek system, terminology, and expiration dates, which make options complicated, confusing, and challenging for anyone but the most advanced traders.
The Bitcoin CFDs Benefits
CFDs let traders speculate on the market value of any asset, depending on the CFD itself. Each broker will offer a unique array of CFDs to choose from. The variety is one of the key benefits, as well as how easy it is to begin trading CFDs for Bitcoin, crypto, stock indices, commodities, forex, and more.
The biggest disadvantages surrounding CFDs are technically due to the trader themselves. CFDs carry more risk due more reward than Bitcoin options and require a lot of skill. These disadvantages can be alleviated with proper risk management and natural talent or practice.
Bitcoin Options FAQ: Commonly Asked Questions About Bitcoin Options
Because of all the strange and unusual terminology, Greek letters, and more in Bitcoin options, many questions remain and even more pop up on a regular basis. We’ve prepared this list of commonly asked questions related to Bitcoin options.
How Do I Trade Bitcoin Options?
Trading Bitcoin options requires a broker that offers such derivatives contracts, and a deep understanding of options contracts which you now have after reading this guide. Even with this knowledge, options can be risky and confusing.
Why Is Trading Bitcoin Options A Bad Idea?
Trading Bitcoin options is generally a bad idea because traders lose money, and they can be expensive just to access. Because of the risk and high premiums, it can be like paying just to lose money.
What Are The Risks Associated With Bitcoin Trading Options?
Like any type of contract, traders can lose all the money they’ve put on the line. Although options contracts are consider lower risk than other types of derivatives, they can result in an all or nothing win or loss type of situation.
Are CFDs The Same As Options?
CFDs are not the same as options, as they are not tied to any expiration date and are much easier to understand and access. CFDs let traders speculate on price action using long and short positions they can open and close at any time. Positions can even be held simulatineously with CFDs.
What Are Binary Options?
Binary options are a yes or no, all or nothing type of options trading strategy. They provide a unique way to get positioned in markets and create hedge positions.
