After the horror of crypto winter, Bitcoin has come back. It is not up to its 2021 peak value. But it is well above its 2022 low. Folks who would like to profit from the ups and downs of this somewhat volatile crypto asset need only open an account with their favorite crypto exchange. Alternatively, they can sign up with someone like Deribit and trade options on Bitcoin. Why trade options versus Bitcoin itself? To make this decision and trade Bitcoin options, you need to understand what options are.
Bitcoin Options Trading
Options are what are called derivative contracts. One does not buy or sell Bitcoin itself but rather the right to buy or sell. Options come in two flavors, calls and puts. The point of options is that buyers of contracts pay money to have the right to buy when Bitcoin goes up or sell when it goes down. The contract for a call or put specifies a price called the strike price. This is the price at which a person can buy or sell no matter how high or how low the price of Bitcoin goes.
Trading Options Allows Traders to Hedge Risk
Options help traders hedge risk and leverage their trading capital. Let us say that you expect Bitcoin to rally. You could buy Bitcoin and then wait and see what happens. One very real risk is that your assumption is wrong and Bitcoin falls in price. You not only did not make money. You lost money in this scenario. If you had purchased a call contract on the same quantity of Bitcoin you would have paid a premium for that right. If Bitcoin fell in price your maximum loss would be the price of the contract called the premium.
Trading Options Allows Traders to Leverage Trading Capital
As in the example above, you expect Bitcoin to go up. You buy ten tokens which amounts to about $37,000 x 10 = $370,000 late in 2023. The price does go up by $5,000 per token and you sell your tokens. Your profit is $50,000 minus fees and commissions. However, you could have purchased call contracts covering those ten Bitcoin tokens for a fraction of the $370,000 that you put at risk. When the price of Bitcoin went up by $5,000 you could sell your option contracts before expiration and gain the same amount or about $50,000 minus fees and commissions. Alternatively, you could buy the tokens at the strike price of $37,000 each and own tokens worth $42,000 each. In either case, trading options allows you to leverage your trading capital at the same time as you are hedging your risk.
Calls Versus Puts in Options Trading
Options trading can be very basic or rather complicated. At its very basic a trader buys a call contract that gives them the right up until the contract expires to buy Bitcoin at a set price no matter high how it might rise. Or they can buy a put contract that gives them the right to sell Bitcoin at the contract price no matter how low Bitcoin falls. In each case, the buyer is under no obligation to do anything unless it is profitable. The seller, however, is paid a premium for taking on the risk that Bitcoin will go up or down contrary to their expectations. Professional option traders commonly use more complicated strategies like vertical spreads where they both buy and sell calls or puts at different price levels. This is typically done to gain a reasonable profit while hedging against downside risk. To do this sort of trading one needs to take the time to learn more about options than is contained in this article.
SlideShare Version – Why Trade Options Versus Bitcoin