Options are for those traders that are happy to accept limited profit for limited risk. An option is a contract that gives its owner the right to buy or sell a fixed quantity of an underlying security at a specific price (strike price) within a certain time constraint. In this case the underlying security is Bitcoin. There are two types of options: calls and puts. A BTC call option is the right to buy 1 Bitcoin at a certain price (the strike price) and a put option is the right to sell 1 Bitcoin at a certain price.
The Bitcoin options on the Deribit platform are European style cash settled options. This means that the Bitcoin options cannot be exercised before expiration but can only be exercised at expiration and will happen automatically. Cash settled means that the seller of the contract pays any profit due to the holder in cash rather than the value of the underlying asset being exchanged. The Deribit platform is based in the Netherlands and was built for those that wanted a professional, fully dedicated cryptocurrencies’ futures and options trading platform.
The options themselves have a value which can be split into two parts: Intrinsic value and time value. Intrinsic value is that part of the options value that is in the money (ITM). Time value is the remainder of the options value and is based on the amount time left until expiration and the price of Bitcoin. A call is in the money (ITM) when the underlying price of bitcoin is greater than the strike price. A call is out the money (OTM) when the underlying price of bitcoin is less than the strike price. A put is ITM when the underlying price of bitcoin is less than the strike price. A put is OTM when the underlying price of bitcoin is greater than the strike price. An example would look as follows
| Security | Strike Price | Underlying Price | Implied Volatility | Expiry Date | Expires in | Bid | Ask |
| BTC-Call | $7000 | $7931.39 | 83% | 25 Oct 2019 | 6 days 14 hours | $959.73 | $987.55 |
The above is an ITM call because the underlying price of Bitcoin is greater than the strike price. A trader buying this call would be buying the right to buy 1 contract of bitcoin with a strike price of $7000. The ask price is $987.55 with $931.39 being the intrinsic value and $55,16 being the time value. The time value reflects that an option is more valuable the further away it is from expiration. In Bitcoin options the buyer of a call would receive the cash settlement if the price of the option increased at expiry.
There are many factors that affect the pricing of an option and these can be explained by the Greeks which are symbols that represent the different elements of how options are priced.
- Delta: It is the change in option price relative to change in the underlying price of bitcoin.
- Gamma: The change in option delta relative to change in the underlying price of bitcoin.
- Theta: Change in option price relative to change in time left to expiration(time decay).
- Vega: Change in option price relative to the change in bitcoins volatility
- Rho: Change in option price relative to changes in the risk free interest rate.
There are four basic strategies that form the foundation of options trading and these will give you the knowledge to learn and understand intermediate and advanced strategies. They are:
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- Long call: The belief is that bitcoin will rise. The risk is the price paid for the option and there is unlimited maximum reward.
- Short call: The belief is that bitcoin will fall. The maximum reward is the price that you sold the option for. The risk is the margin on the trade which can be significant.
- Long put: The belief is that bitcoin will fall. The risk is limited to the price paid for the option. Unlimited maximum reward up to strike price less the price paid for the option.
- Short put: The belief is that bitcoin will rise. The risk is the margin imposed on the trade which can be significant. The maximum reward is limited to the price the option was sold for.
I am not in favor of the long call and long put for two reasons: The first is that it does not give an advantage over leveraged buying or selling of Bitcoin on Bitmex. The second is that you are exposed to Theta which is time erosion. This means that even if bitcoin moves up in price you could still lose money on your options trade because Theta decreases the value of your option daily and this could be greater than the increase in value brought about by the price increase.
I prefer the strategy of selling calls or selling puts. This is because even if bitcoin is in a sideways motion you can still make money because of Theta. In a short option time erosion is your friend because it decreases the value of the option. Shorting options does come with the risk of liquidation. This because a margin is reserved to open or maintain a short position and if this margin is exceeded then your position is automatically closed. This can happen with sudden bitcoin price movements. The margin to open a short position is large so the risk is high. The following is an example taking from live trading. The trade was taken on 22 June 2019
| Instrument | Size | Avg | Mark Price | PNL(ROI) | Initial Margin |
| BTC-26JUL19-7500-P | -0.30 | 0.0115($125) | 0.0149 | -0.0010(-29.57) | 0.0345($376) |
A Bitcoin put option was sold with a strike price of $7500 and expiry date of 26 July 2019. The quantity purchased was 0.3 of a contract. When first trading options it is an advantage that Deribit allows trading as little as 0.1 of a contract. The price of Bitcoin at the buy date was $11 126 and dropped to $10 900. This is why the ROI is showing negative 29%. The Margin is a whopping $376 and the best profit from this transaction is 0.0115 * 0.3 = 0.0345 = 41$. However, despite the poor risk to reward the Greeks and technical analysis does give us hope that we can be profitable
| Delta | Gamma | Vega | Theta |
| 0.0256 | -0.00001 | -1.5826 | 2.5306 |
Delta shows that the option price will move very slowly with each dollar price movement of bitcoin. Theta or time erosion will decrease the price by over 2.5 dollars a day. Vega is the worry because every percentage change in volatility will cause the options price to increase by 1.5 dollars. The volatility will cause the most damage when the price of Bitcoin falls sharply. Theta is the strongest value and because of this there is a higher than average chance of making money on this option despite the risk. If we couple this with technical analysis which shows bitcoin is on a strong uptrend then selling a put will provide profits. The following is the open position on 15 July:
| Instrument | Size | Avg | Mark Price | PNL(ROI) | Initial Margin |
| BTC-26JUL19-7500-P | -0.30 | 0.0115($125) | 0.0039 | 0.0023(+66.09) | 0.0345($376) |
The price of Bitcoin had dropped to $10,605 but the position is still profitable because time erosion has decreased the value of the option. I could buy back the option to make a profit or wait for the option to expire worthless because the strike price is below the underlying price of Bitcoin. If we do choose to wait for expiry then we have to be careful and watch price movements daily because there is no safety net of stops. If we find that our ROI drops to -50% then we can buy back our options for a loss. There are more advanced strategies which provide protection from price movement but these are outside the scope of this article.
Options are not for traders that want maximum profits for their trades. It is for the more conservative trader that wants to accumulate Bitcoin as an asset. Options allow this because in sideways moving markets we can accumulate more bitcoin and increase our asset holdings. The simple strategies are the easiest way to start but they hold risk as explained in the article. However, I do believe that if we use technical analysis and check our positions daily, we can manage the risk and be profitable. In a future article we will introduce more advanced strategies like spreads, straddles and strangles which provide protection from loss.
