26 November 2018: Recent volatility in the Bitcoin price has created great opportunities in Bitcoin Options markets. For example the Dec18 6250 Put did 18x from 4 November to 26 November as a result of Bitcoin price falling from $6,300 to $3,800:
Trading Bitcoin Options at Deribit (Part 1)
This is Part 1 of a 2-part Primer to Trading Bitcoin Options. It is about buying Bitcoin Options. Buying Options is a limited risk trade.
Part 2 will explain how to use the Bitcoin Options Calculators at my site AntiLiquidation, and specifically how to calculate PnL, Maximum Gain & Loss, and Break-Evens before you enter a Bitcoin Options trade. (Deribit has no Options Calculator on its platform.) Part 2 will treat the subject of selling options, also known as writing options, which is much riskier than buying them and carries unlimited risk. It will also take a look at Options strategies, and delve into the Greeks.
Why Trade Bitcoin Options?
Bitcoin Options are a derivative that serve several purposes for Bitcoin traders:
- They provide a way to long and short Bitcoin. Buying put options is a way to make speculative gains from a declining market, and to hedge spot Bitcoin positions.
- They can be used to create leverage, meaning a x % change in the price of Bitcoin creates a greater than x % profit. Deeply out-of-the-money options cost pennies and can yield ultra-high leveraged rewards with an asset as highly volatile as Bitcoin.
- Options have an advantage over futures and perpetual swaps as there is no risk of liquidation. Options buyers maintain their market position from entry to expiry. They cannot be liquidated by adverse market movements, and can participate in any favourable price movements that occur before expiry date. But note that Options writers can get liquidated.
- For options buyers the possible loss is limited to initial investment — the premium you pay when you enter the trade — which is usually a fraction of the Bitcoin price. (But for options sellers a.k.a. writers there is unlimited risk. So for the first six months of trading at least I would advise against all writing of options.)
- Bitcoin options can be used to buy or sell volatility without taking a directional position. So if volatility is very high you can short it by selling an options strategy. If volatility is low you can long it by buying an options strategy. If you are long volatility you win whichever way the price goes, but you lose if it goes nowhere.
Introduction to Options
Watch this video for an introductions to options.
Bitcoin Options: Deribit vs. BitMEX
Bitcoin Options are available at three exchanges, Deribit, BitMEX, and Ledger X. You have to go through relentless KYC at US exchange Ledger X which is anathema to most privacy-loving Bitcoin derivatives traders.
At time of writing [3 December 2018] daily volume at Deribit is ten times that of BitMEX. Deribit is trading about 1,500 BTC of volume daily and BitMEX is trading about 150 BTC of volume.
The main reason for this is that BitMEX only enables the buying of Options; only the BitMEX ‘anchor market maker’ can write Options (i.e. be net short). One entire side of the market is off-limits to mex clients and the absence of competition on the writing side means Bitcoin Options at BitMEX are over-priced and the mex market maker is receiving economic rent from users.
Another disadvantage of BitMEX options is the lack of choice — currently, with the Index at 3865, they only offer one Call (which they call an UP) with 4250 Strike and one Put (which they call a DOWN) with 3750 Strike. And another minus: their Put Options are knockout barrier options; there is a limit placed on the potential profit of the buyer of the DOWN options and on the potential losses of the writer (BitMEX anchor).
So we can safely just forget about mex Options and focus on Deribit.
European vs. American Options
The Bitcoin Options at Deribit are Traded European Options, meaning they can be traded at any time during their lifetime but then can only be exercised at expiry. (American options can be exercised at any moment during their lifetime.) There is a widely-held misconception that this means you can only sell your Deribit Options at expiry. This is wrong, you can sell them whenever you like. In fact I suggest just forget about the ‘Europeanness’ factor.
Bitcoin Options at Deribit
Determinants of Bitcoin Options Prices
A. Time to Expiry
Expiration days are on Fridays, 0800 UTC. Weekly, monthly, quarterly (3 months), and 6 month options are available. The longer-dated the option the more time value you pay for and the more expensive the option. At time of writing these Expiries are available:
B. Intrinsic Value (Strike vs. Underlying) for Calls & Puts
If strike price <underlying price, intrinsic value =underlying Futures price minus the strike price. These options are IntheMoney (ITM). The more ITM the option the greater the premium.
If strike price > underlying, the intrinsic value is zero. These options are OutoftheMoney (OTM)
If strike price > underlying, then the intrinsic value =
strike price minus the underlying Futures price. (ITM)
If the strike price <underlying, the intrinsic value is zero. (OTM)
C. Implied Volatility & Historical Volatility
Bitcoin Options will be cheaper, other things being equal, when the Bitcoin market is calm (low volatility) and more expensive with greater volatility. There are three places to check volatility:
- The Deribit platform
- .BVOL Index of Annualized Volatility Volatility at TradingView
We need to distinguish historical or realized volatility from the Implied Volatility that is implied by Options prices. When a large spread of Implied > Realized develops then Options are not a good bargain for the buyer.
You are Long volatility buying options, and Short volatility selling Options.
Ari Paul’s Million-Dollar Bitcoin Options Trade
Remember this from December 2017? Ari Paul bet a million dollars on December 2018 $50,000 Calls. It’s a good lesson not to buy extremely expensive volatility. Whoever was on the other side of that trade at LedgerX and sold $1 million of ultra-expensive volatility to Ari Paul knew what he was doing.
Buying vs. Writing Options
Buying options is much less risky than writing Options. The risk to the buyer is limited to the premium they pay on entering the trade. The risk to the Writer is unlimited, and may greatly exceed their initial margin if the price moves adversely against them.
We see this in the payoff charts.
P/L for Call buyer [Long Call]:
P/L for Call seller [Short Call]:
On the Deribit platform you have to be careful not to go Net Short in any option. Only sell Options in which you have already bought a position. Be careful with that Sell button!
As an example, consider those Dec18 6250 Puts I bought for 0.042 BTC / $275 and later sold for 0.741 BTC /$2,898 . My risk was limited to the $275 premium I paid at Entry. But the trader who wrote those options and received my initial premium of $275 lost [2,898–275] = $2,623 on every option.
A common criticism of Deribit on Crypto Twitter — made by those who have never traded options there — is that it is insufficiently liquid.
You can mitigate this by choosing to trade those options with the greatest liquidity. Futures & Options liquidity is measured by Daily Volume and Open Interest (the number of active contracts).
So if we are interested in Puts on the 28Dec18 expiry then avoid the 2750 Strike. The 2500 Strike has much better liquidity by both measures.
If we drill down to the 2500 Strike Put (below) we see a pretty health order book. The bid-ask spread of 0.0060 – 0. 0080 is large in comparison with a spot market for Bitcoin, of course, but spreads for equity options are also much larger than for spot equities — it is the nature of the beast for options markets. You should have no problem selling your position without slippage.
Fees for Maker and Taker are the same at 0.0004 BTC per Option.
(You are a Market-Maker if you enter the trade with a Limit order. You are a Market-Taker if you enter the trade with a Market order, accepting a Limit order that already sits in the Order book.)
Although there is no fee advantage in being the Maker, it is good practice to enter and exit Bitcoin Options trades with Limit orders nevertheless as by definition you get a better price than trading at market. So when buying Calls or Puts set your Limit Bid < Market. And when you want to exit and sell your Options, set your Limit Ask > Market.
Note that trading the Bitcoin Perpetual Swap and Futures at Deribit the Maker receives a fee rebate:
Reminder for US Citizens
Trading at BitMEX is against their terms and conditions. Deribit has no KYC.
Sign up using this link (no KYC required):
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Skew: an excellent Bitcoin options resource
Deribit Options Cheat Sheet. This contains a couple of mistakes which I flagged to Deribit but they are too lazy to fix them.