Bitcoin Options and How to Trade Them
Bitcoin options and crypto options are a type of derivatives contract that give investors the opportunity to speculate on market movements to make a profit - and they’re increasing in popularity. We’re covering everything you need to know about Bitcoin and crypto options in this guide, including what crypto options are, how crypto options work, crypto call and put options, and crypto options trading strategies. Let’s go! 📈
What are crypto options?
Crypto options are a kind of derivative contract. As the name suggests, this kind of contract gives investors the option to buy or sell a given cryptocurrency - like Bitcoin - at a predetermined price and date. Investors can use these to make a profit from market price movements, without actually owning the underlying crypto asset.
The concept can be a little confusing to newcomers, and there’s quite a bit of jargon to get through so let’s break it down.
Watch: What are Bitcoin options?
Are there different types of options contracts?
Yes. There are two main types of crypto options - American options and European options.
Both American and European options give you a contract entitling you to the option to buy or sell an asset at a predetermined date and price, also known as the expiration date and strike price.
The key difference between American and European options is exercise rights. In this context, exercise rights refer to your right to put into effect your contract - so either to buy or sell the underlying asset.
American vs. European options
American options give investors the right to exercise their rights and close a position at any point before the specified expiration date. As you can imagine, this flexibility makes them a very popular option.
Meanwhile, a European option only gives investors the right to close a position and end their contract at the specified expiration date. While it might seem obvious to immediately opt for American options, the premium for European options (the price to create your contract and option your position) European options are cheaper.
As well as this, some investors note that European options are lower risk as the expiration date is fixed, meaning the loss or gain can be estimated more easily when you open your position. This means strategizing European options is often easier, especially for those new to options contracts.
Call options vs. put options
As well as the different types of options above, you’ll also see terminology around call and put options frequently when trading options. This is simply market language used to refer to the right to buy or the right to sell an asset:
A call option is the right to buy an asset at a specific price on a specific date.
A put option is the right to sell an asset at a specific price on a specific date.
What is an option premium?
An option premium is the current market price of an option contract. It’s the price paid to the seller, or writer, of the option contract. Regardless of whether you choose to exercise your right or not, you’ll pay the premium.
The price for a premium varies and is generally calculated based on the price of the underlying asset, the volatility in the market, the length of the contract, and the strike price.
In particular, the price of a premium is determined by whether the option is ATM, ITM, or OTM.
Options terminology: ITM vs. OTM vs. ATM
In-the-money (ITM), out-of-the-money (OTM), and at-the-money (ATM) relate to the relationship between the current market price of an underlying asset (like a stock) and the strike price of an option.
In The Money (ITM):
Call Option: ITM when the current market price of the underlying asset is higher than the strike price of the option.
Put Option: ITM when the current market price of the underlying asset is lower than the strike price of the option.
Being "in the money" means that exercising the option would result in a profitable trade, ignoring the premium initially paid.
Out of The Money (OTM):
Call Option: OTM when the current market price of the underlying asset is lower than the strike price of the option.
Put Option: OTM when the current market price of the underlying asset is higher than the strike price of the option.
Being "out of the money" means that exercising the option would result in a trade that's not profitable, ignoring the premium initially paid.
At The Money (ATM):
Call or Put Option: ATM when the current market price of the underlying asset is equal to the strike price of the option.
Being "at the money" means the option's strike price is the same as the current market price of the underlying asset. These options typically have no intrinsic value (though they may still have time value) at that particular moment.
What’s an options position?
The word position is thrown around a lot in the context of options. At its most basic, you can open and close a position. Opening a position means entering into a contract, while closing a position means ending that contract.
Taking it up a notch, a position can refer to the financial stance you’ve taken in regard to a particular contract. There are four basic options positions available:
Buying a call option
Selling a call option
Buying a call option
Buying a sell option
Each of these has implications for long or short positions. In this context, long means betting on a price increase, while short means betting on a price decrease.
Read next: How to short crypto
All this terminology can get a little confusing, so let’s use an example to give a simplified example of how crypto options work before we dive deeper into crypto options trading.
ELI5 Bitcoin Options Example
You think the price of Bitcoin will be higher next month. You don’t have the funds right now to buy Bitcoin, but you do have enough to open a call option position on Bitcoin.
This type of option gives you a contract to buy Bitcoin at a later date but for the current price. There are two potential scenarios a month later:
The price of Bitcoin has gone up. You use your option to buy Bitcoin at a lower price. You could then hodl this Bitcoin, or sell it immediately for a profit.
The price of Bitcoin has gone down or is the same. You decide not to exercise your right. Your only loss is the premium it costs you to open your position as opposed to the price difference in Bitcoin, had you bought Bitcoin at the price it was last month.
In a reverse scenario of our example, if you thought the price of Bitcoin was currently too high and it would go down, you could open a put option position to sell Bitcoin at its current price, at a later date - and make a profit from the difference.
How to trade crypto options
Sign up and onboard with a crypto exchange that offers options trading. We cover the best crypto options trading platforms to research.
Come up with an options trading strategy. While you might luck out and guess right, the most successful options traders have a clear strategy and understand the market and the likely movements well. This includes understanding what drives the price of crypto and knowing how to read crypto charts to analyze the current market.
Open your position. With a clear strategy, it’s time to open your position(s). Many investors opt to open multiple positions in opposite directions to cover any potential losses.
Monitor the market. Even the most experienced investors can have predictions go awry, which is why it’s important to continually monitor your position and your gains or losses so you know when to cash out and close your position.
To help you, we’ll now cover the best crypto options trading platforms and crypto options trading strategies for you to research.
Read next: What are the best crypto options trading platforms?
Crypto options trading strategies
Wise investors come up with a solid trading strategy before diving into any investment - and options should be no exception. Some of the most popular and common crypto options trading strategies include:
Covered Call: An investor who owns shares of a stock can sell a call option on those shares. By doing this, the investor earns the premium from selling the call but agrees to sell the shares at the strike price if the call option is exercised.
Protective Put: This is when an investor buys a put option for a stock they own. This provides downside protection. If the stock price drops below the strike price, the put option will increase in value, offsetting some or all of the losses from the stock.
Protective Collar: This involves owning shares of a stock, selling a call option, and using the proceeds to buy a put option. This caps both the potential upside and downside for the stock.
Long Call Spread (Bull Call Spread): The investor buys a call option and sells another call option with a higher strike price but the same expiration date. This reduces the upfront cost but also caps the potential profit.
Long Put Spread (Bull Put Spread): The investor buys a put option and sells another put option with a lower strike price but the same expiration. It's a way to profit from a moderate decline in the stock price.
Long Straddle: The investor buys a call and a put option with the same strike price and expiration date. This strategy profits if the stock makes a large move in either direction.
Long Strangle: Similar to the straddle but the investor buys out-of-the-money call and put options. It requires a larger move in the stock price to be profitable but is cheaper to establish than a straddle.
Long Call Butterfly Spread: The investor buys one lower strike call, sells two middle strike calls, and buys one higher strike call. This results in a net debit position. The strategy profits if the stock stays near the middle strike price.
Iron Condor: A combination of a bull put spread and a bear call spread. The investor sells an out-of-the-money put, buys a further out-of-the-money put, sells an out-of-the-money call, and buys a further out-of-the-money call. The maximum profit is the credit received, and it is achieved if the stock finishes between the middle strike prices.
Iron Butterfly: The iron butterfly is similar to the iron condor but uses at-the-money options. The investor sells an at-the-money call, sells an at-the-money put, buys an out-of-the-money call, and buys an out-of-the-money put.
Remember, while these strategies offer various ways to approach the market, each comes with its own set of risks. It's important to understand these risks and have a clear strategy before entering any options trades.
What are the benefits of crypto options trading?
Crypto options trading comes with many benefits, including:
Leverage: Options allow traders to control a larger position with a relatively small amount of capital.
Flexibility: Traders can use options for a variety of strategies, from simple to complex, depending on their market view.
Hedging: Options can be used to protect crypto holdings against adverse price movements, acting as a form of insurance.
Diversification: Options provide an additional asset class for diversification within a broader crypto trading portfolio.
Defined risk: When buying options, the maximum loss is limited to the premium paid.
Potential for high returns: Depending on the strategy used, options can offer the potential for substantial returns.
Strategic alternatives: From bullish to bearish or neutral, options allow traders to capitalize on any market outlook.
Premium collection: Sellers of options can earn a premium in exchange for taking on the obligation of the option contract.
No obligation for buyers: Option buyers have the right, but not the obligation, to exercise their options. If the market doesn't move as anticipated, they can simply let the option expire worthless.
Access to price movements of expensive assets: We can’t all afford to buy BTC. With options, traders can gain exposure to the price movements of high-priced cryptocurrencies without having to fully invest in them.
Time decay as a strategy: Options have an expiration date, and the value of the option can decrease over time due to time decay. This can be utilized as a strategy by option sellers.
It's essential to understand that while crypto options offer numerous benefits, they also come with significant risks, so we’ll cover that too.
What are the risks of crypto options trading?
As with all investments, crypto options have risks too, including:
Complexity: Options can be complex and require a solid understanding to use effectively, making them less suitable for new investors.
Potential for loss: If an option expires out-of-the-money, the premium paid for it is entirely lost.
Leverage risk: While leverage can amplify gains, it can also magnify losses.
Liquidity issues: Some crypto options might have low trading volumes, leading to wider bid-ask spreads and making them harder to buy or sell.
Short selling risk: Sellers or writers of naked or uncovered options can face unlimited losses, unlike buyers whose loss is limited to the premium paid.
Regulatory and platform risks: The regulatory landscape for crypto options can be uncertain and subject to change, affecting trading or the validity of contracts. Some platforms might also face security issues.
Volatility: Cryptocurrencies are notoriously volatile. Such volatility can lead to options becoming in-the-money or out-of-the-money very rapidly.
Time decay: Options have an expiration date. The value of an option can decrease rapidly as it approaches its expiration if it remains out-of-the-money.
Costs and fees: Trading fees, margin requirements, and other transaction costs can eat into potential profits or amplify losses.
Understanding these risks is crucial before engaging in crypto options trading. You should only ever invest what you can comfortably afford to.
What’s the difference between spot trading vs. options trading?
The main difference between spot trading and options trading is that with spot trading, you own the asset you’re trading, whereas with options trading you have a contract that gives you a right to buy or sell an underlying asset at a later date. There are other key differences between crypto spot trading and crypto options to compare as well, including:
| Feature | Spot Trading | Options Trading |
|---|---|---|
| Definition | Buying or selling an asset at its current market price. | Buying or selling the right, but not the obligation, to purchase or sell an asset at a predetermined price by a specified future date. |
| Capital Requirement | Amount equivalent to the asset's current price multiplied by the number of units bought/sold. | Premium paid or received. This is typically much less than the cost of the underlying asset. |
| Profit Potential | Unlimited, based on how much the asset's price rises (for a buy) or falls (for a sell). | For option buyers: Unlimited (for calls) or up to the strike price (for puts). For option sellers: Limited to the premium received. |
| Loss Potential | Up to the full value of the asset (if it becomes worthless). | For option buyers: Limited to the premium paid. For option sellers: Potentially unlimited for selling calls; up to the strike price minus premium for selling puts. |
| Complexity | Straightforward buy or sell. | Can be complex with various strategies involving multiple options. |
| Purpose | Investment or speculation based on asset's future price. | Speculation, hedging, income generation, or strategic positioning based on future price or volatility. |
| Ownership | Actual ownership of the asset when bought. | No ownership of the underlying asset, unless the option is exercised. |
| Duration | Can hold indefinitely (unless it's a contract with an expiration). | Fixed expiration date. |
| Liquidity | Depends on the asset and market. Some assets are highly liquid; others are not. | Can vary widely. Popular options might be highly liquid, while others are not. |
| Dividends/Interests | Eligible if holding dividend/interest-paying assets. | No direct entitlement. However, option prices might factor in expected dividends/interests. |
What’s the difference between crypto options vs. crypto futures?
The main difference between crypto options and crypto futures is with crypto options, you are not obligated to buy or sell the underlying asset, whereas with crypto futures, you are obligated to do so. Other key differences between crypto options and crypto futures include:
| Feature | Crypto Options | Crypto Futures |
|---|---|---|
| Definition | Contracts giving the holder the right, but not the obligation, to buy or sell a cryptocurrency at a predetermined price by a specified date. | Standardized contracts obligating the buyer to purchase, and the seller to sell, a cryptocurrency at a predetermined price and date. |
| Obligation | Buyer: No obligation, only a right. Seller: Obligation if the option is exercised. | Both buyer and seller have an obligation to fulfill the contract. |
| Capital Requirement | Premium paid or received. This is typically less than the cost of the underlying cryptocurrency. | Initial margin requirement, which is a fraction of the contract's total value. |
| Profit/Loss Potential | Buyers: Limited loss (the premium paid) with potential unlimited profit for call options and profit capped at the strike price minus premium for put options. Sellers: Profit limited to the premium, but potential loss can be significant, especially for call options. | Unlimited profit or loss potential based on the difference between the contract price and the market price at settlement. |
| Complexity | Can involve various strategies and combinations. | Relatively straightforward, based on the anticipated future price of the cryptocurrency. |
| Purpose | Speculation, hedging, or strategic positioning based on anticipated price movements or volatility. | Hedging or speculating on the future price of the cryptocurrency. |
| Expiration | Fixed expiration date. Some platforms might offer early exercise depending on the option style (American vs. European). | Fixed expiration date, after which the contract is settled. |
| Settlement | Can be cash-settled or physically-settled, depending on the contract terms. | Typically cash-settled, but some contracts might allow for physical delivery of the cryptocurrency. |
| Liquidity | Depends on the platform and the specific option. Might be less liquid than futures. | Generally more liquid than options due to standardized contract terms and more extensive usage. |
| Rights vs. Obligations | Buyers have rights; sellers have obligations. | Both parties have contractual obligations. |
How are crypto options taxed?
In short, generally profits from crypto options are subject to Capital Gains Tax. You can learn everything you need to know about how crypto options are taxed in our guide.
FAQs
More questions about crypto options? We got you covered.
Are there crypto options trading platforms in the USA?
Yes. There are crypto options trading platforms in the USA, although compared to the rest of the world these are limited due to the harsher regulatory environment in the USA. One notable CTFC-approved and regulated provider is Crypto.com.
What are crypto binary options?
A crypto binary option is a kind of options contract where the two parties involved are assigned one of two outcomes, based on whether the option expires in the money. You can think of it like taking a bet out with a bookmaker. They’re higher risk they’re a kind of winner-takes-all all contact, but they do have fixed payouts and losses, making it easier to understand your potential gain or loss.
Where to trade crypto options?
Some popular crypto options trading platforms include Binance, Crypto.com, Bybit, OKX, and Deribit. You should always DYOR before investing.
Can you trade options on crypto?
Yes! Crypto options trading, particularly for Bitcoin options and Ethereum options, is becoming a more common product offered by crypto exchanges, allowing investors access to potential profits with lower risk than other crypto derivatives products.
