How Can I Trade Bitcoin Options?
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Any two people with opposing positions on the future of the state of bitcoin’s price can negotiate the terms of an options agreement. This type of options trading is known as over-the-counter (or OTC), but good luck finding the other party. If you are trying to do the deal in a timely fashion, OTC options trading is hard.
Nowadays, several blockchain-based venues cater to parties looking to purchase options on cryptocurrencies. These decentralized markets are still minuscule, but let’s look at how to trade call options in a timely way on a decentralized options exchange if you are an absolute beginner.
There is always someone else that takes a different view of the future price of bitcoin (or BTC). For traders that want to speculate on the price of BTC (or the underlying), that someone else is called the counterparty. A trader can’t speculate on the underlying without a counterparty.
Fortunately, there is no need to waste time looking for one. The Ethereum Network’s got your back. There are several decentralized venues for buying and selling cryptocurrency options.
According to total value locked (or TVL) on DeFiPulse, the most popular blockchain-based venues presently are:
- Hegic ($58.7M) [1]
- Opyn ($2.7M)
- Opium ($0.1M)
- Auctus ($0.07M)
The choice of venue will depend on your goals and the level of your options knowledge and experience. [2]
Call Options Fundamentals
Forget Bitcoin. Suppose Alice wants the right to buy ether (or ETH) for $800 seven days into the future through an options contract, she wants a long call option that expires in seven days. Before she can obtain the right, there must be someone else willing to sell ETH to her for $800 in the future.
If Bob comes along and wanted to oblige, they would strike a deal. In options parlance, Bob wants a short call option and $800 would be the strike price.
Bob would charge Alice a $15 fee (or option premium) for acquiring the option to buy ETH for $800 in seven days. Should this scenario play out, Bob would be the writer of Alice’s option.
The hardest part of making all this transpire is getting Alice and Bob to meet. Fortunately, Hegic, Opyn, Opium, and Auctus make it trivial for all of this to go down.
Simplicity Rules
Although Auctus and Opium have lovely features, Hegic is king for trading decentralized WBTC and ETH options. Hegic not only has greater transaction volume but also (with its informative graphics and intuitive UI) facilitates the trading process for neophytes.
Comparatively, Opyn is not suitable for newbies that want to speculate. Opyn’s focus is on buying and selling options as insurance.
Opium is also out. It’s is too rigid for most beginners. That’s because Opium’s European-styled Options may only be exercised at expiration.
When purchasing options for the first time, traders may want the flexibility of being able to sell the long call option and not just exercise the option at expiration. This is one reason a beginner should prefer Auctus over Hegic.
Price Speculation
Options are traded for insurance, to provide income, and to speculate. Speculation is easy to do with options.
Absolute beginners usually wager that the price of the underlying is going way up and are bullish, or the reverse (that the price is going way down) and are bearish. Hegic makes the process seamless for this type of speculative options trader.
Hegic allows newbie traders to speculate with leverage even if they possess zero knowledge of the fundamentals of options trading.
Leverage
Purchasing call options on decentralized options exchanges is the easiest way to get leverage on your discretionary funds whenever you feel the price of bitcoin or ether is certain to rise. The amount of leverage achieved is largely a function of the market price (or last price) of the underlying, the strike price of the option, and its premium.
When the price of the underlying exceeds the sum of the premium and the strike price, the rate of return is determined as follows:
Option Return Rate = (Underlying — Premium — Strike) / Premium
Compare this to the rate of return for buying (at the entry price) the underlying and holding it:
Underlying Return Rate = (Last Price — Entry Price) / Entry Price
If you were to plot a graph of the option return rate versus the underlying return rate for Bitcoin on Hegic, you would notice that options provide massive leverage.
Chart 1 shows that 9X leverage is achieved with only a 7% change in the price of BTC. The leverage realized varies. For example, if you were to extend Chart 1 out it would reveal 16X leverage if the price of BTC jumped 15%.
No doubt, options trading can be lucrative.
All options traders need to understand that the smaller the premium (with respect to the price of the underlying), the greater the leverage.
Increased Risk
Massive returns are only realized when your position on the future price of the underlying is correct before the options expire. This makes options trading as risky as it is lucrative for those that buy calls or puts.
This is especially true on Hegic. Hegic uses volatility estimates from Skew to adjust premiums. The higher the implied volatility, the higher the premium.
This knowledge is important. Speculators should always assume that the odds are stacked against them when they accept the premium offered by Hegic. It’s buyer beware with options trading.
[1] Hegic is 95% of the decentralized options market on the Ethereum Network.
[2] FinNexus also exists although no mention of them is made in DeFiPulse.
