There are a large number of assets and trading possibilities in the cryptocurrency market. But there are also many different tools to trade these assets. One of the possible solutions is called derivatives. Derivatives are a type of financial contract that derives their value from other assets (the underlying asset).
Some of these derivatives include cryptocurrency options. These options make it possible for investors to get access to different trading strategies without having to buy or sell the underlying digital asset. Futures are different from futures and they offer different solutions for investors in the cryptocurrency market.
We have decided to create a guide in which we will tell you all you should know about cryptocurrency options and how they work. Furthermore, we will get into the details of how options work and why they can be useful for investors from all over the world.
Disclaimer: the information shared by AltSignals and its writers should not be considered financial advice. This is for educational purposes only. We are not responsible for any investment decision you make after reading this post. Never invest more than what you are able to lose. Always contact your professional financial advisor.
What are Cryptocurrency Derivatives?
In order to understand what cryptocurrency options are, we need to get into the details of cryptocurrency derivatives and the way in which they work. Derivatives are basically financial contracts that derive their value from an underlying asset. As we are talking about the cryptocurrency market, these derivatives will derive their value from different virtual currencies.
There are many cryptocurrencies that can be used by traders. Some of them include Bitcoin (BTC), Ethereum (ETH), Binance Coin (BNB), Litecoin (LTC), Solana (SOL) and Ripple (XRP), among others. The variety will also depend on the liquidity and the requests from users.
Thanks to the expansion of digital assets, it is now possible to trade contracts on a regular basis on different cryptocurrency exchanges. But there are different types of contracts that will suit the needs of many different investors in the cryptocurrency market. We can trade cryptocurrency futures, options, forwards, warrants and swaps, among others.
Derivatives are very useful to execute advanced trading strategies that would be not possible to conduct in the spot market. This is why derivatives are usually used by advanced and expert traders. Indeed, it is highly recommended for investors to use derivatives only if they fully understand how they work.
One of the reasons why investors would like to use derivatives is due to the fact that they can hedge risk ro gain extra exposure to the cryptocurrency market. This is something that might not be easy to do using the spot market. Nevertheless, there are many ways in which you can execute these trading strategies using different derivatives, including options and futures.
What are Cryptocurrency Options?
But what are cryptocurrency options and how can they help investors execute their strategies? First of all, cryptocurrency options are derivatives (contracts) that derive their price from a specific cryptocurrency, let’s say Bitcoin. There are many other digital currencies that can also be used to trade cryptocurrency options.
Options are very useful for investors because they give the possibility to investors to buy or sell an underlying asset at a specific price and throughout a specific period. The important word here is that there is an option to exercise this right to buy or sell the underlying asset, not an obligation.
In order to enter this trade, the investor has to pay a fee. This fee fluctuates according to the market. But once the trader has decided to purchase cryptocurrency options, they are already analyzing what is happening with the market and how this could impact their trades.
Therefore, these are contracts that give the right (but not the obligation) to buy or sell an asset at a stated price and during a specific period of time. It is possible to use options for different reasons, including hedging risk or even speculating on the price of an asset that could move higher or lower in the future.
Bitcoin and cryptocurrency options have been expanding over the last few years. They are now becoming one of the largest derivatives in the market in terms of volume. Indeed, in some exchanges, derivatives are already having more volume than the spot market.
Due to the fact that Bitcoin has a volatile price, it could be more difficult for investors to understand which is a good price for BTC or not (when it comes to options). This is why you might see variations in price that you do not see in the spot market. Therefore, understanding volatility is also a very important thing to be able to trade options and other derivatives in the market.
It is worth taking into consideration that large companies are already working with cryptocurrency derivatives in the market. We are talking about companies such as the Chicago Mercantile Exchange (CME), which started offering investors the possibility to trade Bitcoin futures. Nowadays, this is the best platform for large investors to get exposure to derivatives in the market.
Where to Trade Cryptocurrency Options?
Thanks to the expansion of the cryptocurrency market, we now know that there are many platforms where we can trade cryptocurrency options. Most of these platforms are crypto exchanges that have large volumes and that offer not only spot trading to investors but also derivatives and more advanced trading solutions.
Some of these crypto derivatives exchanges include Binance, Deribit, Bybit, BitMex, OkEx and many others. The market has been expanding for many years now and options became a key feature of trading solutions for investors all around the world.
There is no one platform that offers better solutions than others. Indeed, most of these platforms tend to have similar solutions and services offered to trades. However, there could be some differences in terms of availability in your region (not all platforms are available in all countries) and in terms of liquidity.
If you are a large trader or you want to have a more efficient market, the best thing to do is to use the exchange with the largest liquidity. In this way, you will be able to get access to some of the best solutions offered in order to trade cryptocurrency options in the market.
It is worth taking into consideration that besides traditional cryptocurrency exchanges offering options, there are some forex and commodity brokers that are also offering derivatives for virtual currencies. These traditional trading platforms and broker platforms realized that there was a large need from investors to start trading virtual currencies.
It is up to you to decide whether you use a traditional brokerage platform to trade cryptocurrency derivatives or if you use a crypto exchange.
Pros and Cons of Cryptocurrency Options
There is a wide range of pros and cons that we should consider about cryptocurrency options. And of course, you should take into account your needs and how they could affect your trading activities.
Pros
- With volatile assets they could be much safer and less risky than trading spot
- They offer different solutions for investors that want to expand their trading strategies
- Options could be very profitable if you properly open positions
- You can trade options in a large number of trading platforms around the world
- Options can be a good alternative to futures
- Most trading platforms have large liquidity for options
Cons
- Options can have higher commissions
- They might not be profitable when the market trades sideways
- It might be difficult to predict an outcome
- They can be used by advanced users and traders
- You can also lose all your invested capital if the trade does not go in the direction expected
Risks of Trading Cryptocurrency Options
But which are the risks that we could face when trading cryptocurrency options? There is a list of things that we should take into consideration when it comes to trading options. One of the things that you should know about trading options is that you are risking your principal capital.
That means that when you open an options position, the principal could get lost if the trade does not execute in the way you were expecting. Therefore, you might end up risking your entire premium.
Moreover, there is also a risk of unlimited loss. We are talking about the possibility of losing more than what you already invested. For example, if you open a put position (short), and the asset starts moving higher, then there is an unlimited loss that you could face if the asset continues to move higher.
Instead, when you open a long position (call option), then you can expect to lose all your funds if the market moves downwards and goes to zero. But there is a clear and defined limit to your losses with call options. Instead, with put options the risk is even larger and “unlimited.”
Another thing that you should take into consideration is that options could involve trading with leverage. That means that you could get a larger exposure to the market but it is also a riskier thing to do. Suppose that you used leverage and you do not have enough margin to keep your position opened. This could create a situation in which your position will get closed and you will register a clear loss.
Despite the fact that trading with leverage can be risky, it is also a good way for advanced and experienced investors to increase their exposure to some trades that seem to be going in the right direction. But there are risks that you should consider when trading options and derivatives.
