The novel features of cryptocurrencies, combined with earning opportunities, disrupted multiple traditional financial systems. They even entered derivatives trading, offering additional methods for investors to make profits from crypto price trends. Crypto options trading is one of the crypto derivatives trading that allows investors to leverage the price movements of cryptocurrencies.

Now that you have discovered on how much to invest in cryptocurrency in one of our blog posts , you might be wondering how traditional investment strategies like options trading can be applied to cryptocurrencies, this article is for you. Here, we explain crypto options trading and help you understand how they work in detail.

What is Crypto Options Trading?

Options trading, in traditional investments, allows investors to make profits based on price movements of the underlying assets, without directly owning them. Similarly, crypto options trading helps investors to make profits based on the price movements of cryptocurrencies, without actually buying them.

Options trading is a contract between buyers and sellers to take action when the underlying asset meets the predefined price at a predefined time. Even though the concept seems similar to futures contracts, they are not. Buyers and sellers are obligated to execute the trade when the predefined conditions are met. But, in the case of options trading, buyers and sellers are not obligated to the contract. They have an option to choose whether to execute the trade or not, making them “option contracts”.

How Does Crypto Options Trading Work?

When it comes to the functionality of crypto options trading, there are three things to keep in mind – strike price, expiry date, and premium. The strike price is the price of the underlying cryptocurrency defined in the contract. The contract buyer holds all the rights to execute the contract, which include buying or selling the underlying cryptocurrency at the strike price. The expiration date is the settlement date of the crypto options contract. And, the premium is the price you need to pay to buy the options contract.

As per the options contract, if the price of the underlying asset meets the conditions of the contract, the contract buyer will execute the trade. Executing the trade can involve either buying or selling of the underlying assets, whatever is mentioned in the options contract. Crypto options trading gives an additional way of generating income for investors apart from regular crypto trading.

Types of Crypto Options Contracts

Crypto options are categorized into different types based on when buyers and sellers execute the trade. For instance, in American style of crypto options trading, the trades can be executed at any time before the expiration date. Whereas in the case of European style options trading, trades can only be executed at the expiration time. However, in some cases, even in the European style options trading, trades can be executed before the expiration based on the buyer’s choice.

Apart from that, crypto options trading is divided into two types – Call Options and Put Options.

Call Options

A call option involves buying of the underlying asset at a predefined price. When you estimate the future strike price of the underlying asset will be lower than the market price, then you can enter this type of contract to make a profit.

For instance, you bought a Bitcoin options contract with a strike price of $30,000 and a premium of $10. Let us assume that the expiration date of this contract is 10 days. If the Bitcoin price went up to $35,000 in the next 10 days, you can execute this contract and buy Bitcoin at the predefined strike price, $30,000. This way, you can make a total profit of $4,990.

Put Options

Put options trading is the opposite of call options and it involves selling of the underlying asset at the strike price of the contract. This type of options trading is suitable when you estimate that the strike price of the underlying asset will be higher than the actual market price. You will execute the put option, which has a higher strike price, and sell the asset at this price, the price difference will be your profit.

Let us understand how option trading works with an example. Assume that you’ve bought a Bitcoin put options contract, that has a strike price of $35,000 and a premium of $20, with a 10 days expiration date. When the current market price of Bitcoin reaches, for instance, $32,000, you can execute this contract and sell the underlying asset at $35,000. This way, you can make a total profit of $2,980.

Benefits of Crypto Options Trading

Risk Management

One of the main benefits of crypto options trading is the option to choose whether to execute the trade or not. If the market prices do not move as per your estimation, you can choose the option to not execute the trade and only lose the premium amount. This limits the risk of losing funds when we compare it to investing directly in cryptocurrencies.

Flexibility

Unlike crypto futures trading, there is a flexibility to choose in the case of crypto options trading. Adding to that, options trading gives investors the flexibility to choose strike prices, expiration dates, and how they would like to execute their trade. There are also multiple types of trading strategies that you can implement with options trading.

Leverage

Options trading also gives access to the leverage, allowing you to hold a large value of the underlying assets with small amounts of capital. Even though leverage trading helps you make make substantial profits, there is also a risk of losing substantial funds if things don’t go your way.

Diversification

Crypto options trading helps investors to diversify their portfolio and distribute the investment risk evenly. They act as another method to have exposure to the crypto market for traditional investors, who hesitate to invest in crypto directly.

Risks of Crypto Options Trading

High risk

Crypto options trading also comes with risks such as volatility and counterparty risk. The crypto market prices are extremely volatile, which can result in unpredictable price swings and render options contracts worthless. If the other party involved in options trading does not fulfill their obligations, the contract buyer will be left with losses.

Regulatory uncertainty

The crypto industry is still in its early stages, which implies that there are no proper rules and regulations in place. This applies to crypto options trading as well and the lack of regulation can result in frauds.

Complexity 

Buying options contracts and executing the agreement is complicated for beginner investors. It requires knowledge and experience before estimating which options contracts will be profitable.

Conclusion

Crypto options trading is a method of leveraging cryptocurrency price trends, without actually owning a crypto wallet and buying cryptocurrencies. While they offer an incredible opportunity to make profits, there are also several risks associated with them.

Beginner investors need to be cautious before engaging with crypto options trading as they can be complicated to understand and trade. If you would like to start trading crypto options, make sure you research and understand the concept and choose the best and most reliable crypto options trading platforms to start with.

Frequently Asked Questions (FAQs)