Bitcoin (BTC) trading has gained significant momentum over the past decade, leading to the development of sophisticated financial instruments such as Bitcoin options. These trading instruments enable traders to speculate on Bitcoin’s future price movements and hedge against potential risks.
This guide provides a thorough insight into Bitcoin options trading, assisting you in mastering this rewarding but nuanced domain. So, let’s jump in.
Understanding options
Options are a form of derivative contract. Their value is tied to the behavior of an underlying asset, like stocks, bonds, or in this context, Bitcoin. These contracts grant the holder the option (without the necessity) to buy or sell the asset at a set price within a designated period.
A derivative contract might sound complex, but they have deep historical roots, dating back to ancient Greece. Today, they constitute a significant portion of the global derivatives market, estimated to be worth over $500 trillion.
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Getting familiar with options trading – Image via Pixabay
Crucial option trading terms
To navigate the world of Bitcoin options trading, it is essential to familiarize yourself with some key terms:
- Call: If you anticipate prices to rise, you can buy a call option, allowing you to buy at an agreed strike price even if the price has appreciated.
- Put: Conversely, if you expect prices to fall, you can purchase a put option, giving you the right to sell the cryptocurrency at the agreed strike price, even if prices have dropped.
- Strike price: It is the predetermined price at which the option holder has the right to either purchase or sell the underlying asset.
- Premium: This is the price paid to buy the option. It is calculated based on various factors, including volatility, expiry date, and the spread between the strike price and the current price.
- Maturity: This is the final day on which the option can be exercised. After this date, the right to buy or sell at the strike price becomes void.
- Trade date: The date the option order is executed, should the holder exercise the option.
- Delivery date: This is the date on which the option is fulfilled or settled upon being exercised.
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Trading Bitcoin options
Trading Bitcoin options parallels the typical call and put options. Yet, there are distinct differences that set Bitcoin options apart from traditional ones.
Firstly, they are European-style options, meaning they can’t be exercised before the expiry date. However, they can be bought or sold before the expiration. Secondly, while options contracts on stocks are based on 100 units, Bitcoin options deal with single units due to the high price of Bitcoin.
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How to trade Bitcoin options: A tutorial
Now that we have all the basics cleared let’s walk through the process of trading Bitcoin options step-by-step.
Step 1: Choose a trading platform
Select from platforms like Deribit, LedgerX, Binance, Bybit, BitMEX, or OKX that offer Bitcoin options trading. After researching the ideal one for your needs, create an account, provide the necessary identification, and undergo a know-your-customer (KYC) process. Ensure your platform choice is secure, user-friendly, and offers reasonable fees.
Step 2: Deposit funds
After account approval, deposit funds into your account. Depending on the platform, you may deposit Bitcoin, fiat, or both. Some platforms may offer a wallet service, while others will provide deposit addresses. Ensure to double-check addresses before initiating any transfers.
Step 3: Select an option type
Decide between a call or a put option. The choice depends on your research and speculation, so be careful while opting for any one of these.
Step 4: Determine strike price and expiry date
Set a strike price that you think will favor your selected option the most. Also, choose an expiration date or maturity date for the contract.
Step 5: Place the order
With parameters set, place your order. This will require paying a premium, the upfront cost of the option.
Step 6: Monitor and close the position
Regularly track the market and your position. As expiration approaches, you can decide to:
- Exercise the option: Buy/sell Bitcoin at the strike price.
- Roll it over: Extend the duration, possibly with different terms.
- Let it expire: If the option is out-of-the-money and not beneficial to execute.
Step 7: Withdraw or reinvest
Depending on your success, you can withdraw your profits or place them back into further option contracts. For optimal results, continually educate yourself on options trading, and consider seeking expert advice when needed.
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Learning how to trade Bitcoin options – Image via Pixabay
Bitcoin options trading strategies
There are various strategies that traders can employ when trading Bitcoin options, depending on their market outlook and risk tolerance. Some common strategies include:
Protective put
- What it is: Buying a put option while holding onto the underlying asset, in this case, Bitcoin.
- Rationale: This is essentially an insurance strategy. If you believe there’s a risk of Bitcoin’s price falling in the near future, but you don’t want to sell your holding, you can buy a put option. If the price does fall, the increasing value of the put can offset the losses on your Bitcoin.
Covered call
- What it is: Selling a call option when you own the equivalent amount of the underlying asset.
- Rationale: If you believe Bitcoin’s price will remain relatively stable or rise slightly, you can earn additional income by selling call options. You receive the premium immediately. However, if the price rises significantly and surpasses the predetermined strike price, the buyer may exercise the option, and you’ll need to sell your Bitcoin at the strike price.
Straddle
- What it is: Simultaneously buying a call and a put option with identical strike prices and expiration dates.
- Rationale: This strategy is useful if you anticipate a big move in Bitcoin’s price but are uncertain about the direction. If the price shifts significantly in either direction, one of the options will become profitable, potentially offsetting the loss of the other.
Strangle
- What it is: Like a straddle, but the call and put options have altogether different strike prices. Typically, the call’s strike price is higher than the current market price, and the put’s strike price is lower.
- Rationale: You’d use this strategy if you expect a significant price move but are uncertain about the direction and believe there’s a higher likelihood of it hitting one of the two strike prices.
Risks in Bitcoin options trading
Options trading with Bitcoin carries distinct risks. When buying an option, the most you can lose is the premium you paid. Conversely, selling an option poses a theoretically unlimited risk, as you’re obligated to fulfill the contract regardless of Bitcoin’s price.
Bitcoin’s inherent volatility means its price can change swiftly and dramatically, potentially amplifying losses or gains. Additionally, navigating options trading demands a thorough grasp of market dynamics and trading strategies, given its intricate nature. It’s crucial for traders to be well-informed and cautious when participating in such complex financial activities.
Unraveling Bitcoin option trading strategies and risks – Image via Pixabay
Conclusion
Bitcoin options trading presents a plethora of possibilities for astute traders. Nevertheless, mastering the market nuances and having a coherent strategy is crucial for effective navigation.
By grasping the intricacies of Bitcoin options and judiciously mitigating your risks, you stand a chance to reap notable gains in this vibrant and evolving market. But it’s imperative to trade with caution and only invest what you’re willing to part with.
