While the Bitcoin market has made a dramatic level of progress, especially considering where it was in just the past few years, there is one element that has yet to gain as much traction as of yet.
So what is this aspect? That would be the Bitcoin option markets.
And it's unfortunate that it hasn't matched the rest of the progress of Bitcoin, but it's mainly due to the fact that Options represent a great way to trade assets which demonstrate a higher level of volatility. These are also effective instruments to use for managing and assessing the risk in a portfolio.
And while the market is limited in the ways that it is, there are, on the other hand, a number of places that do offer this kind of support, allowing for trading in either a physical or synthetic form.
In this post, we will take a quick look at these as well as how you can trade them.
So, before there's any closer observation of some of these Bitcoin options, we have to take into consideration of what financial options are exactly and how they really work.
Options – These are derivative instruments that can provide the holder with the right, but not the obligation to buy or sell an asset at some predetermined time in the future.
If we take into consideration that there is this optionality in the payoff, it is an asymmetric one. Unlike with futures, they don't have a continual linear payoff in terms of gains and losses. There are others that use a call and put option payoff system as opposed to a long and short futures contract.
What we can see from these systems is that having access to these options allow the trader to cap their losses. In this regard, the loss that the trader may incur is limited to the cost of the option (option premium).
Now that you have an idea of how options function, let’s take a look at some of the best places to trade them.
While the BitMEX Exchange is primarily regarded as a futures exchange, they have a unique futures contract referred to as the ‘limited loss' contract.
Basically, these are a type of futures contract that has a defined maximum loss that the trader will take before their position is immediately liquidated.
This sets it apart from traditional futures markets where, instead of a liquidation, you get what is referred to as a margin call. And if you can't meet your margin call, then you can still be liable for losses. It's for this reason that the standard futures contracts can be considered riskier.
When you place a trade on BitMEX, you will be able to put up an initial margin for your chosen position. This margin can be considered to be analogous to the option premium that you would spend on a traditional Bitcoin option.
Should the price of the futures contract go against your position, then the BitMEX liquidation engine will be sure to close out that same position before it manages to eat away at the remainder of your invested capital.
While these same futures contracts may appear to be an attractive instrument, they are still not purely option instruments in the traditional sense. As a result, they may not react to adjustments for the likes of volatility and other market factors as well as traditional options will.
For those that have been on the virtual hunt for cryptocurrency options, then the chances are they you've already heard of Deribit. And that they are a relatively small exchange based out of Amsterdam.
What sets them apart as a company is that they are one of the only exchanges that list standardized Bitcoin options. But while the volumes are relatively thin and the option notionals are on the lower end of the spectrum, their option order books prove to be more than sufficient when it comes to trader demand.
They operate in relatively the same way as any other physical Bitcoin exchange, in that you are placing an order for an option on the company's books. However, unlike with the physical manifestation, there are a number of other options contracts which have their own corresponding order books.
These option markets will differ according to the strike price, the expiry date and whether it is a CALL or a PUT.
It's with this system, if you are placing an order for the price of the option itself. These are all cented on the underlying price of Bitcoin, which is roughly $6,700 at the time. Should you wish to adjust any of the option parameters, then you'd need to take that on in a new order book.
You may also notice that there is a further away aspect, that should you take the strike away from . the current price, the market may gradually become increasingly illiquid. This is due to the general lack of users who know how to trade options.
Should you be one of the more advanced option traders, then you can also place specific orders with more specific criteria for trading them. These are sometimes called the option “Greeks” but a discussion of that is beyond the scope of this piece.
When it comes to the world of options trading, we have just scratched the surface of its potential. And apart from just being able to protect portfolios, or placing down a one-way betting on the value, there are a vast host of other option strategies that you can choose to work around.
These strategies are used extensively in established option markets and allow the trader to maximize their returns merely based on the underlying volatility in the asset. For this reason, there are a large number of option desks in investment banks which are called ‘volatility desks'.
So, does this mean that we could eventually see Bitcoin volatility desks making an appearance soon?
As Bitcoin faces more Wall Street adoption, you can be certain that portfolio managers will be looking for alternative ways to optimize their portfolios.