In this era of technological advancement, we find ourselves at a crossroads between traditional finance (TradFi) and the burgeoning field of cryptocurrency (crypto).
Both have their unique appeals and are shaping the way we conduct financial transactions and investments.
While TradFi represents the established, regulated financial systems and instruments we're all familiar with, crypto introduces a decentralized, highly digital, and often volatile alternative.
The popularity of options strategies has surged in recent years, thanks in part to Wall Street Bets. Is the crypto counterpart different? Is it profitable? Here’s what you need to know.
An Overview of Options
Options are a financial strategy that many investors use to mitigate risk and increase returns. With options, investors can buy or sell securities at a predetermined price within a specific timeframe.
This is known as a physically settled options contract. It provides investors flexibility in managing their portfolios based on market conditions and their own individual objectives.
There are also cash-settled option contracts, and it’s important to understand the differences. Unlike physically settled options, where the underlying asset is delivered to the option holder once the contract expires, cash-settled options are settled with a cash payment instead.
You won't actually own any of the underlying assets, but rather, you'll profit (or lose) based on the difference between the option's strike price and the asset's price at expiration.
Cash-settled options can be confusing initially, but they are often used for trading indices, commodities, and crypto. Because there's no physical delivery of the underlying asset, cash-settled options can provide a more flexible and less complex way to invest in markets that otherwise would be difficult to access.
In addition, options can be used to generate income through writing (selling) options or they can be used to hedge against existing holdings.
Education Makes a Difference
As options trading continues to gain traction among crypto investors, the role of education in helping traders harness their trading skills cannot be overemphasized.
This explains why seasoned investors are drawn to crypto derivative platforms that offer low fees for trading and provide educational content to help their traders.
There are crypto derivatives platforms such as Deribit, which boasts some of the lowest fees in the industry and offers a dedicated educational library with video tutorials, trading guides,simulated trading environment, etc.
Another popular platform is Bybit where crypto traders are eligible to earn cryptocurrencies for completing educational courses on options trading
How Options Work in TradFi
Here’s an example from TradFi: An investor is eyeing a stock. It’s currently trading at $22, and the investor thinks buying at $20 is a fantastic deal.
The investor writes an options contract. In this case, they are selling a put. The contract states that the investor will buy 100 shares of the stock at the strike price of $20, provided the stock trades at the price (or lower) stated in the contract upon the expiration date.
In TradFi, stock options contracts are for 100 shares, and an investor can write as many contracts as they like. It’s important to note that this 100 share per contract rule only applies to US stocks. It does not exist in many other forms of options contracts, including crypto.
If the stock price is $19.90, the investor still pays $20 per share. If it drops to $15, the investor still pays $20 per share. Because of the risk involved, the seller of the put contract is paid a “premium” for writing the contract.
No matter what happens, the investor keeps the premium. That’s why options can be considered an income strategy. The premium is paid out as soon as a buyer for the contract is found, and the investor pockets that income.
In this example, the investor is paid $100 in premium for writing the put. On the contract's expiration date, the stock is trading for $21.50.
The investor does not receive the stock, but the collateral they used, which would be for the full value of 100 shares at $20 per share, is returned to them.
Crypto: A New Frontier for Options
If you're new to crypto options or options in general, start slow with simple techniques. One of the best starting points for new options traders is covered calls.
Covered Calls in Crypto
Covered calls involve selling call options on a crypto asset you own in exchange for cash premiums while holding onto the asset as a form of insurance.
If the asset's price rises above the call option's strike price, the buyer can exercise the option, and you'll have to sell it at the agreed-upon price.
However, if the stock doesn't rise above that price, you still get to keep the cash premium and the asset. Although some risk is involved, this approach can be a useful way to generate extra income while staying diversified in your investment portfolio.
For example, you have 1 ETH. Its current value is $2,000. You go to a platform like Deribit and sell a covered call at the strike price of $2,500. It expires in one month. You are paid a premium by the buyer for the equivalent of $100 in the underlying asset.
At expiry, if ETH is lower than $2,500, you keep your ETH and the premium paid, giving you a profit of $100 worth of that asset. However, if ETH goes over $2,500, you'll be forced to sell that ETH at the strike price, even if it's substantially higher than $2,500.
If ETH does go to $2,500, you still make a profit, provided you paid less than $2,500 for the ETH. And your premium is now worth more than $100.
Are Crypto Options Right For You In 2024?
Traditional finance and cryptocurrency offer options strategies as a viable path for potential profit and risk mitigation.
While the principles of options remain consistent across both landscapes, the highly volatile nature of the crypto market can result in substantial profit through strategies like selling covered calls.
However, this volatility also introduces a significant level of risk. Thus, it's crucial to thoroughly understand the mechanics of options trading in the crypto space and utilize available resources to make informed decisions.