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Beginner's Guide: Options Trading in Crypto

Beginner's Guide: Options Trading in Crypto 

by RocketFuel Team


Options are a powerful derivative instrument that can provide leverage for speculation, risk protection for an underlying asset, flexibility to trade bi-directionally, and a means to generate monthly income. However, there is significant risk* when options are misunderstood and misused.

This guide, brought to you by Rocketfuel, starts with the basics of options and then progresses to advanced trading strategies using a combination of spreads. A glossary of terms relevant to these strategies is also provided.

*Options trading strategies in crypto are relatively new and carry additional risks compared to traditional markets. It is crucial to consider execution risks, liquidity, and regulatory uncertainties before engaging in crypto options trading. This guide is for educational purposes only.

Basic Concepts

Call Options

A call option contract gives the buyer the right, but not the obligation, to buy a security or financial asset at an agreed-upon price (strike price) on or before a specific date (expiration).

Why Buy or Sell a Call Option?

Consider the analogy of a real estate investment. Suppose an investor expects the value of a piece of land to increase. Instead of purchasing the land outright, they acquire an option to buy it at a fixed price in the future. If the land appreciates, they can either exercise the option or sell it for a profit.

Similarly, in crypto options trading, a trader can buy a call option on Bitcoin (BTC) if they believe its price will rise. If BTC's value increases above the strike price, the trader can either exercise the option or sell it for a premium.

Put Options

A put option contract gives the buyer the right, but not the obligation, to sell a security or financial asset at its strike price on or before expiration.

Why Buy or Sell a Put Option?

Consider a car insurance policy: the policyholder pays a premium to secure the right to claim a payout in case of an accident. Likewise, in crypto trading, a trader may buy a put option on Ethereum (ETH) if they anticipate a decline in price. If ETH's price drops below the strike price, they can exercise the option and sell ETH at a higher price, offsetting potential losses.

Risk Graphs in Crypto Options Trading

Risk graphs help visualize the risks associated with a given position. Unlike traditional equity options, where risk graphs assume a standard contract size (e.g., 100 shares per contract), crypto options often have different contract structures. For instance, on platforms like Deribit, each option contract may represent one BTC or ETH. Traders should be aware of platform-specific risk calculations.

Crypto Options Spread Strategies

This guide covers foundational strategies, with more advanced techniques explored in later parts.

Covered Call Strategy

A covered call strategy involves holding an underlying crypto asset while selling a call option to generate premium income. It is ideal in a range-bound market, which is rare in crypto due to high volatility.

Example (using simple numbers):

  • A trader buys 1 BTC at $9,271.

  • They sell a call option with a $10,000 strike price, earning a $297 premium.

  • If BTC remains below $10,000 at expiration, the option expires worthless, and the trader keeps the premium.

  • If BTC surpasses $10,000, the trader may need to sell BTC at the strike price, but they still retain the premium.

Protective Collar Strategy

A protective collar consists of holding a crypto asset, buying a put option to hedge against downside risk, and selling a call option to finance the put purchase.

Key Considerations:

  • This strategy reduces downside exposure while capping upside potential.

  • Most crypto exchanges do not support simultaneous spread orders, requiring traders to leg into positions manually.

  • It is useful when a trader expects short-term price fluctuations but wants long-term exposure to the asset.

Additional Considerations for Crypto Options

Unlike traditional markets, crypto options introduce unique challenges:

  1. Liquidity Constraints - Crypto options markets may have lower liquidity, leading to higher spreads and slippage.

  2. Settlement Mechanisms - Some exchanges use cash settlement, while others involve physical settlement of the asset.

  3. Volatility Factors - Crypto markets are inherently volatile, impacting implied volatility and option pricing models.

  4. Regulatory Risks - Different jurisdictions have varying regulations regarding crypto derivatives trading.

Glossary of Key Terms

  • American-style option: Exercisable at any time before expiration.

  • European-style option: Exercisable only at expiration (common in crypto).

  • Implied volatility (IV): Expected future volatility of the underlying asset.

  • Intrinsic value: The real value of an option if exercised immediately.

  • Time decay (Theta): The erosion of an option’s value as expiration approaches.

  • Margin requirements: The collateral required to maintain an options position.

Conclusion

Rocketfuel is dedicated to equipping traders with the knowledge needed to navigate the dynamic world of crypto options. These instruments provide unique opportunities for risk management and speculative trading. However, due diligence is necessary to navigate execution risks, market liquidity, and regulatory uncertainties. Traders should experiment with paper trading and risk management strategies before committing capital.

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