Many times snubbed by small investors in favour of other more mainstream instruments, often associated with the financial crisis of 2008 with the expression “financial derivatives” that over time has taken on an increasingly negative connotation, finally explained in such a convoluted way that even the most willing student who does not have a degree in mathematics can escape.
So much mistreated by retail investors and yet so used by large investors in traditional markets. We are talking about the famous (or infamous) Options. In this article we will try to clarify what they are and try to show that the bad reputation they enjoy in the eyes of the general public is actually unfounded and that, on the contrary, if used correctly and consciously, they have features that make them very useful tools to enrich their arsenal of investment and trading strategies. In order to do this we start from clarifying the basic concept, that however many people manage to make complicated already in departure.
What is an option?
The option can actually be considered as an insurance on the asset that we hold, Bitcoin in our case, against a particular scenario that we think or fear may occur. In order to have this possibility, this “option” in fact, you pay an initial amount (just like one you pay the insurance premium at the time of taking out), high or low depending on the probability that the scenario has to occur. And just as in the case of an insurance, the option has an expiry date, at the choice of those who buy it, beyond which it is no longer valid and exercisable by the owner.
If our vision is an increase in the price of bitcoin, we will buy an upward option that “protects” us from a price increase beyond a certain value and will allow us to buy BTC in the future at a cheaper price (strike), decided by the buyer at purchase. This type of option is called a CALL option.
If, on the contrary, our view is bearish, we will buy a down option that protects us from a decrease in bitcoin value below a value of our choice (always called a strike). This option is called PUT.
And now the question that arises: “but if my vision is bullish, why not buy Bitcoin now before the price goes up? And if it’s bearish, why not sell now?” Well, the advantage of the option is precisely this: it gives us the opportunity to delay the decision at a later date. If we have been right, the insurance/option will make us collect the price difference between the value decided at the time of conclusion and the actual value on the day of sale (or expiry of the option). Otherwise, the option expires and we will have lost the premium initially paid. It should be noted that, as in the case of an insurance policy, the maximum loss is the amount paid at the time of conclusion. There is no liquidation risk, so much so that no maintenance margin is required for the purchase of options and there is no additional “hidden” outlay beyond the initial payment for the purchase.
Where to buy options on bitcoin and how: the differences between providers
Surely the first market to be mentioned in this sense is the CME, Chicago Mercantile Exchange, where futures and options are listed on traditional financial markets. Since 2020, options on Bitcoin have also been added. The same goes for the BAKKT platform which is part of the ICE group. However, trading in these markets is only open to institutional and professional investors. A common investor who wants to buy options on Bitcoin must rely on other types of platforms. Almost all exchanges offer the possibility to buy futures, but not options on Bitcoin, which today is the prerogative of only Binance, FTX, Deribit, Okex and LedgerX. Are they all equivalent? What are the differences?
While for futures, all exchanges provide similar, if not identical services, for options, the situation is different: Binance and FTX provide a service only on demand, i.e. there is no market with a bid and offer book as we are accustomed to see, but you need to request a particular option with the desired characteristics and expect a quote from the exchange itself or another user of the platform intending to sell it to us. This type of transaction can be defined as OTC, i.e. each option is tailored to the applicant and is only recommended to experienced users who know what they are doing, as this type of market is less liquid and less transparent.
Deribit, Okex and LedgerX instead offer a type of trading similar to that of any cryptocurrency or futures on cryptocurrency, and on the mold of listed options, then standardized, with a buying and selling book, and equal features for each market participant. This feature makes buying and selling, and understanding what you are doing, easier.
LedgerX, however, for now is only open to US citizens.