What is Crypto Options Trading & How is it Taxed?
Crypto options trading often offer traders a low-cost and low-risk method for trading their crypto assets, and are becoming more popular all the time. Here we break down all the important aspects of crypto options trading. This includes options, premiums, the difference between call and put, American and European style, and how your profits are taxed. So let’s waste no more time and jump in.
What is crypto options trading?
In simple terms, crypto options are a type of derivative contract that provides the trader with the right to buy or sell an asset at a determined price and date.
What is an option?
There are two styles of crypto options: American and European.
An American option is where a buyer can exercise the contract at any time before the expiry date
Meanwhile, a European option is where a buyer is only able to exercise the contract at the moment of expiry.
While European-style options can only be exercised at expiry, they can still be traded (sold to someone else) or closed out early if the buyer wants to do this.
An option is a type of contract that gives its purchaser the right (but not the obligation like in futures options) to buy or sell an underlying asset at a set price or an expiration date.
How to trade crypto options
In options, each contract has an expiration date and a strike price. This is when the contract must be settled by and refers to the price at which the contract buyer has the right to buy or sell the underlying asset upon expiry.
The right to buy the underlying asset is known as a 'call' option, and the right to sell is known as a 'put' option.
What is a premium?
The cost of an option is known as a ‘premium’.
A person buying a put is doing so as downside protection, like an insurance. Premiums mean that if the price of their underlying asset should go below the strike price (the price at which a put or call option can be exercised) the option’s owner is pretty much guaranteed. The options writer will buy from the owner the asset at that fixed price. In other words, it minimizes risk.
Like insurance, the price of premiums depends on a number of risk factors. These include the time remaining on the contract, volatility (hiya crypto), interest rates and the current price of the asset.
As mentioned, the current price of the asset plays an important role in dictating the option's premium costs.
There are three sets of circumstances when it comes to being involved in a position:
- In the money (ITM): This is a good thing for the trader. For a call, this is when the strike price is lower than the current price of the underlying asset. For a put, it’s when the strike is higher than the current price.
- At the money (ATM): When the strike is equal to the current price (for both a call and a put)
- Out of the money (OTM): This is a bad thing for the trader — for a call, this refers to when the strike price is higher than the current price of the underlying asset. For a put, it’s when the strike is lower than the current price.
A trader wanting to buy a call option with a strike price that is lower than the current market value of the underlying asset will have to pay a higher price for the premium. When you think about it, this makes total sense because if the contract is ‘in the money', it has current value. Of course, this doesn’t guarantee the price will continue to stay above the strike price before the contract expires.
Example
The price of 1 BTC is $32,000 in May, but Trader A thinks by the end of September the price will go up. He decides to buy 10 call options at a strike price of $35,000 for a 0.010 bitcoin premium per contract. This expires on the 30th September.
0.010 BTC $35,000 is $350 at the time Trader A purchases the call options. 10 x 350, which equals $3,500. Trader pays $600 for his premium.
Each contract gives Trader A the right to purchase 0.1 of a bitcoin at the price of $35,000 per BTC. This means Trader A can buy 1 bitcoin at $35,000 when the contract expires at the end of September, regardless of what the actual price is.
Now, let’s consider two scenarios. The first one leaves Trader A feeling happy.
Scenario 1) Upon expiry, bitcoin’s price is $40,000. Trader A, with a big smile on his face, exercises his call option and makes a $5,000 profit ($40,000-$35,000=&5,000). Take away the cost of the premium ($600), and Trader A is left with a healthy $4,400 profit.
Scenario 2) Upon expiry on 30 September, BTC price has tanked to $28,500. Trader A decides not to exercise his call option because it’s “out of the money.” He does not lose thousands but will have to pay the price for the $600 premium, resulting in a total loss of -$600.
Considering that the Trader would have made over $4k if it went well, and only lost the cost for the premium should things go bad, the whole idea of the trade seems pretty reasonable. The risk / reward ratio is unequal.
Where to trade crypto options
Here are some of the best exchanges for trading options on crypto.
- Deribit: Deribit provides European-style options, meaning such options can only be exercised at the time of expiration date. Also, the settlement happens in cash instead of the underlying asset
- Binance Options: Binance is the leading global cryptocurrency trading platform and allows you to trade crypto options through its Binance Futures platform, which was launched in 2020.
- LedgerX: LedgerX is a US-based exchange offering Bitcoin options trading since October 2017.
- Quedrex: another European-style options trading platform that allows you to trade Bitcoin options and settle in cash.
How are crypto options trading taxed?
In short: capital gains.
Although discussions within tax authorities are still ongoing regarding taxation of certain cryptocurrencies, including that of crypto options trading, the best fit for it is Capital Gains Tax.
If you're seen to be trading as an individual investor, you'll pay Capital Gains Tax on profits from futures (as well as margin trades and other CFD). So when you open a position, you won't pay tax. It's only when you close your position that you'll realize a capital gain or loss and pay Capital Gains Tax or claim a capital loss.
How can Koinly help with crypto options trading taxes?
Koinly is a crypto tax tool that calculates your crypto taxes for you, meaning you don’t have to go through the hassle of doing it yourself. Essentially, Koinly does all the boring tasks that would cost your hours and hours sitting at a computer.
Here’s a short summary of what Koinly does.
- Converts your transactions into your country’s currency at fair market value (this in itself is a massive time saver).
- Deciphers which crypto events are taxable and which are not.
- Allows you to submit a clean and accurate report to your tax office.
