If you are new to the world of finance, you may feel lost or intimidated when it comes to crypto options trading. The good news is that crypto options trading is more simple than it sounds!
The first thing to know is that many activities in DeFi mirror traditional finance. So if you understand how options trading works, you will understand how crypto options work. This guide offers a broad introduction to everything crypto options trading.
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What is options trading?
Let’s begin with securities. While the definition of a security is often broadly interpreted, securities are generally accepted as tradeable financial assets. Examples of securities include stocks, bonds, or exchange-traded funds (ETFs).
Next, we have derivatives. Derivatives are a type of security with a price “derived” from an underlying asset. The underlying asset may be another security, like a stock, bond, or commodity. If you think we’ve gone full meta at this point, that’s because we have!
If you’ve ever seen the movie “Inception,” you will likely be pfamiliar with the concept of a dream within a dream. Well, a derivative is like a security of a security. Some examples of derivatives include swaps, futures, and — you guessed it — options.
Options are a type of financial product that give investors the right to buy or sell a security (e.g., a stock) at a predetermined price and date. If the holder decides not to buy or sell the asset, they are not obligated to do so, and each options contract will have an expiration date by which the holder must exercise their “option.”
To purchase an options contract, an investor must pay a premium. We refer to the cost of an option as a premium. When you pay a premium, you acquire the right to buy or sell a predetermined amount of stock on a predetermined date. The strike price is the price at which you can buy or sell the underlying. The underlying is the stock, commodity, or digital assets upon which the option is derived.
Call and put options
There are two broad types of options — calls, and puts. When you buy a “call” option, you have the right, not the obligation, to buy a stock at a predetermined price (the strike price) within a specified time frame (the expiration date). The call buyer has the option to purchase the security until the expiration date. You can refer to the call seller as the writer. The writer must sell the security at the strike price until the expiration date.
When you buy a “put” option, you have the right to sell a stock at a predetermined price (to the writer) until the option expires. The put option buyer has the right to sell the stock at the agreed-upon price until the time frame expires. However, they are not required to do so.
Here’s an example
Let’s break this down. If a stock is trading at $40 and you believe that it will go up to $50, you might buy a $45 (strike price) call option for $0.20 (premium). If the stock rises to $50, you can buy it for $45, even though it is valued at $50. This would give you a $4.80 net profit.
Conversely, the writer of the option is obligated to sell you the stock at $45, with a net loss of $4.80. If the price of the stock never rises above $55 by the expiration date, the call is worthless. The buyer is out of $0.20, and the call seller keeps the $0.20.
Here’s another scenario. A stock is trading at $60, and you believe that it will go down to $50. You might buy a $55 put option for $0.20. If the stock drops to $50, you could sell the stock to the writer for $55, even though it’s worth $50. This would give you a $4.80 net profit.
The writer is obligated to buy the stock from you and has netted a loss of $4.80. It is worthless if the stock price doesn’t drop below $55 by the expiration date. The put option buyer losses $0.20, and the writer keeps $0.20.
Call vs. put options
An investor who purchases a call hopes to profit when the price of a stock rises. The investor anticipates the price of the security will rise, allowing them to purchase the stock at a lower cost. On the other hand, the writer hopes that the stock price will fall or remain constant, so they don’t have to exercise the option.
A put option allows the investor to profit when the stock price falls. In this case, the put grows in value as the stock falls in value. So, while the investor hopes that the stock price falls, the writer hopes it rises or remains constant, so they do not have to exercise the trade.
When the strike price of a call option is less than the underlying asset’s current price, the option is said to be in the money (ITM). For a put option, you are ITM when the strike price is higher than the current price.
Out of the money refers to when the strike price of a call option is more than the current value of the underlying asset (OTM). When the strike price for a put is less than the current price, this is considered OTM. When the strike price is equal to the current price, it is called “at the money” (ATM).
Vanilla, exotic, and binary options
A vanilla option is a type of financial instrument that allows its holders to buy or sell an underlying asset at a predetermined price and time frame.
With these options, traders do not have to wait until the maturity date to close. A vanilla option is a call or put option with no special or unusual characteristics. They are standardized if such options are traded on an exchange, such as the Chicago Board Options Exchange.
Vanilla options are the most common type of options contracts known to market participants. Vanilla comes in two flavors (pun intended): European and American styles. You can only exercise European Style Options at expiration; however, for American-style options, you can exercise any time before expiration.
Exotic options have special conditions. Barrier options, for example, include a level that, if reached, causes the option to begin or cease to exist. If the underlying price is above or below a certain level, digital options pay the owner. The payoff of an Asian option is determined by the average traded price of the underlying instrument over the option’s life.
A binary option is a financial contract that depends on whether the option expires in the money. The participants of the transaction are allocated one of two outcomes. The name binary refers to the fact that binary options depend on the result of a “yes” or “no” proposition.
If the binary option expires in the money, traders are paid out; if it does not, they lose money. In binary options, the payout and loss amounts are fixed, and traders are unable to invest in the underlying security. The majority of binary options trading takes place outside of the U.S.
Binary options are prone to fraud. To avoid loss, it is best to restrict your binary options trading to Designated Contract Markets (DCM).
Crypto options trading
Trading crypto options is very similar to traditional options trading. Crypto options give an investor the right to buy or sell a cryptocurrency at a predetermined price and date. Although crypto options work similarly to traditional options, they have advantages over traditional ones.
Crypto assets are volatile; this is more of a feature than a bug. Higher volatility, in some cases, can lead to higher returns. Also, most options traders enter contracts through over-the-counter (OTC) agreements. This introduces counterparty risk and is often time-consuming and expensive.
DeFi crypto options platforms use smart contracts in Decentralized Options Vaults (DOV) to remove counterparty risk. Smart contracts remove counterparty risk and allow crypto options to trade 24/7.
DOVs’ primary function is to use investor capital and execute options trading strategies in a completely automated and decentralized fashion. Prior to DOVs, only accredited investors had access to exotic options strategies via over-the-counter (OTC) trading or self-execution on options exchanges like Deribit.
Crypto options trading strategies
No one enters a battle without a game plan. If you want to become a successful crypto options trader, you need a couple of game-winning strategies.
Covered call and covered put (married put)
One of the most popular options trading methods is the covered call, usually referred to as the buy-write approach. The strategy is straightforward: you buy or hold the underlying crypto while writing (selling) call options on that asset. If you intend to store your crypto for a considerable amount of time but don’t anticipate a major value increase in the near future, this choice works well.
In a way, covered calls behave like yield farming strategies. For instance, if you have $1000 worth of XRP and don’t anticipate any big changes in its price, you may sell $20 call options with a strike price of, say, $1100 in three months.
Your call option would be useless to the buyer if the price of XRP does not rise above $1099 (because he may purchase the same amount of XRP on the open market for a lower price). But you would have made $20 in profit. In this case, you would receive an annual yield of 8%; if you were passively HODLing, no yield would have been produced.
When you sell a covered call option, the intention is for it to expire worthless. This will allow the trader to profit from the option’s premium while retaining full ownership of the underlying asset as collateral.
Married put (covered put)
The married put is an alternative scenario to a covered call. Instead of selling call options to earn yield, you sell put options to earn yield. If you sell a put option, you are obligated to purchase the asset from the option buyer at the strike price, should they execute the option.
When traders anticipate that the underlying asset’s value will drop below the strike price before the crypto option expires, they can earn yield by selling a put. Remember that if the underlying asset’s value falls below the strike price at expiration, the writer of the put option will lose money on the trade.
Like with a covered call option, when you sell a covered put option, the intention is for it to expire worthless. This is so the trader can profit from the option’s premium while keeping all of their collateral.
Bull call spread
When traders have a bullish view of the underlying cryptocurrency, they use the bull call spread strategy. This crypto options trading strategy involves purchasing calls at a specific strike price. Then, selling the same number of calls at a higher strike price. In this strategy, the trader buys two call options, one with a higher strike price and one with a lower strike price. The implementation goes as follows:
- Select the asset.
- Purchase a call option with a strike price above the current market and an expiration date, and pay the premium.
- Sell a call option with a higher strike price and the same expiration date as the first call option. Collect the premium at the same time.
Using this strategy, the trader limits their profits if their predictions are correct. However, they also limit their net premium spent, as purchasing naked calls is expensive.
Bear put spread
A bear put spread is another options strategy. In this situation, a trader anticipates a drop in the price of a security or digital asset and wishes to lower the cost of holding a trade. A bear put spread is created by buying put options. At the same time, the trader sells the same number of puts on the same asset, with the same expiration date, at a lower strike price. The maximum profit from this strategy is equal to the difference in strike prices minus the net cost of the options.
There are many more strategies for options trading. These include the bull put spread, bear call spread, the long straddle, the protective collar, or even the box spread. As crypto options platforms become more advanced, we will see an explosion of value from more complex trading strategies.
Exchanges where you can trade crypto options
Now you know how to trade crypto options, but where should you make these trades? Crypto options are becoming a more attractive financial product; therefore, there are a number of platforms on which you can start crypto options trading right now. The list below includes some of the all-around best exchanges for beginners and offering crypto options.
Bybit
The Bybit exchange provides USDC options that are margined and settled in USDC. Options on Bybit are cash-settled in the European style. You can only exercise them when the contract expires. You can also use Bitcoin options with Bybit to speculate on the price of Bitcoin without buying or owning the underlying crypto asset.
Trading cryptocurrency options on Bybit incurs three types of fees: trading, delivery, and liquidation. The trading fees are 0.02% for the maker and 0.02% for the taker. The delivery fee is 0.015 %, and the liquidation fee is 0.2%.
Binance
The world’s largest exchange, Binance, collaborates with sophisticated market makers. It offers options traders some of the lowest fees in the market (0.02% transaction fees and 0.015% exercise fees). Options on Binance require traders to pay only the options premium in order to gain the same exposure as holding an equivalent Futures or Spot position.
Binance prices and settles options in stablecoins, making it easy for investors to calculate cost and profit. Unlike coin-margined options, stablecoin options allow investors to enter and exit positions securely during periods of high volatility. They can do this without being concerned that the underlying collateral’s nominal value will drastically devalue.
OKX
Our next exchange, OKX, currently offers European-style options contracts with multiple due date options. They settle their contracts for options in BTC, ETH, SOL, and other cryptocurrencies. This removes geographical and currency constraints from options trading on exchanges.
The fee structure of OKX’s options trading platform is tiered. Fees vary by VIP users — assets (USD) ≥ 100,000 and 30-day trading volume ≥ 5,000,000 — and regular users — determined by OKB holdings, assets < 100,000, or trading volume < 5,000,000.
For regular users, the maker fees are 0.02%-0.015% and the taker fees are 0.03%. VIP users’ maker fees are 0.01%- (-)0.01% and taker fees are 0.02%-0.013%.
Lyra
The first platform, Lyra, is a crypto options automated market maker (AMM). It allows traders to buy and sell cryptocurrency options against a pool of liquidity. Because the protocol is on layer-2 Ethereum (Optimism and Arbitrum), users can benefit from low trade fees.
It works because liquidity providers (LPs) deposit a stablecoin into one of the asset-specific Lyra Market Maker Vaults (MMVs). This liquidity is used to make two-sided (buy and sell) option markets for the asset that the vault specifies. LPs provide liquidity into the vault to earn the fees paid when options are traded.
Dopex
Another options trading platform, Dopex, is a decentralized protocol for maximum liquidity and little exposure to risk. Using rebates and delegated controlled incentives for option liquidity providers, Dopex seeks to maximize option liquidity while avoiding losses.
Option pools, also known as farms on Dopex, are essentially liquidity pools where users provide liquidity of a base and a quote asset for option buyers. This allows you to earn passive income by charging option buyers fees to use your liquidity. Furthermore, you can earn rDPX if traders make a net profit to cover your losses.
Depending on the option length, option pools operate on a weekly or monthly basis. The longer you lock your capital, the higher the rewards.
Is options trading profitable?
Options trading can be profitable for some. But when most people hear about options Greeks — the factors that influence options pricing (i.e., theta, vega, delta, and gamma) — they run for the hills. This is not without reason. It is unknown how many traders profit from options trading. However, it is generally accepted that selling options is more profitable than trading options.
Despite this, when options trading pays off, the returns are significantly higher than the cost. Furthermore, many people use options to hedge themselves against potential loss. Therefore, in some situations, traders consider options less risky than other forms of trading.
Crypto options are simple: trading is complex
At their core, most financial products are simple in concept. However, just as human activities become complex, so do our financial markets. It’s easy to get lost in the sauce. That is what makes trading crypto options complex. When you start to create exotic strategies to arbitrage and hedge, you can end up down a complex rabbit hole. If you’re still keen to try out crypto options trading, sign up for a demo account and see how you fare. You won’t risk any real capital, but you will get a glimpse of this growing financial markets sector.
Frequently asked questions
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