Options Trading Basics
What Are Options
An Option is a contract that trades the right to buy or sell an asset at a specific price. While futures represent an obligation to buy/sell, options represent a right. If unfavorable, you simply don't exercise it.
Option buyers pay a premium (price) and receive the right. Option sellers receive the premium but take on an obligation.
Think of it like insurance: buying an option is like purchasing insurance, and selling an option is like selling insurance. The buyer pays the premium (insurance cost) and receives protection from risk.
Call Options and Put Options
Call Option
The right to buy an asset at a specific price.
- Buy when betting on price increase
- If you hold a BTC $100,000 call option and BTC rises to $120,000, you can exercise the right to buy at $100,000 for a $20,000 profit
Put Option
The right to sell an asset at a specific price.
- Buy when betting on price decrease or hedging against downside risk
- If you hold a BTC $100,000 put option and BTC falls to $80,000, you can exercise the right to sell at $100,000 for a $20,000 profit
The Four Option Positions
| Position | Directional Bias | Maximum Profit | Maximum Loss |
|---|---|---|---|
| Long Call | Bullish | Unlimited | Premium |
| Short Call | Bearish/Neutral | Premium | Unlimited |
| Long Put | Bearish | Strike Price - Premium | Premium |
| Short Put | Bullish/Neutral | Premium | Strike Price - Premium |
An option buyer's maximum loss is limited to the premium paid. This is the biggest difference from futures. In futures, you can lose your entire margin, but with option buying, you cannot lose more than the premium.
Strike Price
The strike price is the price at which the option can be exercised.
When BTC is currently at $100,000:
| Call Option Strike | Status | Intrinsic Value |
|---|---|---|
| $80,000 | In-the-money (ITM) | $20,000 |
| $100,000 | At-the-money (ATM) | $0 |
| $120,000 | Out-of-the-money (OTM) | $0 |
In-the-Money, At-the-Money, Out-of-the-Money
- In-the-Money (ITM): Would be profitable if exercised now
- At-the-Money (ATM): Strike price equals current price
- Out-of-the-Money (OTM): Would result in loss if exercised. Only time value exists
A call option is ITM when the strike is below current price; a put option is ITM when the strike is above current price.
Premium (Option Premium)
Components
An option's price (premium) consists of two components:
Premium = Intrinsic Value + Time Value
Intrinsic Value
The profit if the option were exercised now. Only exists for ITM options.
- Call option: Intrinsic value = max(Current price - Strike price, 0)
- Put option: Intrinsic value = max(Strike price - Current price, 0)
Time Value
The value of the possibility that the option moves favorably before expiration. The further the expiration and the higher the volatility, the greater the time value.
- Time value decreases as expiration approaches (Time Decay)
- ATM options have the highest time value
- Time value becomes zero at expiration
Expiration
Expiration Types
| Type | When Exercisable | Characteristics |
|---|---|---|
| European | Only at expiration | Most crypto options |
| American | Any time before expiration | Rare in crypto |
Most cryptocurrency options are European style. They can only be exercised at expiration, but you can close your position by selling the option itself in the market before expiry.
Cryptocurrency Options Expiration Cycles
| Expiry | Description |
|---|---|
| Daily | Expires every day. Short-term trading/hedging |
| Weekly | Expires every Friday |
| Monthly | Expires last Friday of each month |
| Quarterly | Expires last Friday of March, June, September, December |
Large volumes of options are exercised or expire worthless on expiration days, which can increase price volatility.
Options vs Futures
| Aspect | Option Buying | Futures |
|---|---|---|
| Maximum Loss | Premium (limited) | Entire margin (liquidation) |
| Leverage | Implicit (exposure relative to premium) | Explicit (set multiplier) |
| Time Decay | Yes (disadvantage) | No |
| Liquidation Risk | None | Yes |
| Flexibility | Various strategies possible | Only long/short |
| Complexity | High | Medium |
The biggest advantage of option buying is no liquidation. Once you pay the premium, your position is maintained until expiration. No matter how much price moves against you, there's no additional loss.
The disadvantage is time decay. Even if price moves as expected, if it takes too long to reach expiration, you can incur losses from time value erosion.
Major Exchanges
| Exchange | Features | Market Share |
|---|---|---|
| Deribit | Largest crypto options. BTC/ETH focused | ~85% |
| OKX | Various altcoin options | ~5% |
| Binance | BTC/ETH options | ~3% |
| CME | Regulated market. Institutional only | ~5% |
The cryptocurrency options market is dominated by Deribit. Options-related data (IV, put/call ratio, max pain, etc.) is mostly based on Deribit data.
Basic Options Strategies
Protective Put
A strategy of holding spot BTC while buying put options. The put option offsets losses when price falls.
- Purpose: Downside protection
- Cost: Put option premium
- Suitable for: Long-term holders defending against short-term declines
Covered Call
A strategy of holding spot BTC while selling call options. Generates additional income through call premiums.
- Purpose: Additional income while holding
- Risk: Miss out on gains if price surges above strike
- Suitable for: Generating extra yield in sideways markets
Straddle
Simultaneously buying a call and put at the same strike price. Betting on significant movement in either direction.
- Purpose: Betting on volatility itself
- Cost: Combined call + put premium
- Suitable for: Before major events (FOMC, ETF decisions) when direction is uncertain but large moves are expected
Options as Market Sentiment Indicators
Put/Call Ratio
The ratio of put option volume to call option volume.
| Put/Call Ratio | Interpretation |
|---|---|
| Below 0.5 | Extreme bullish. Call demand dominant |
| 0.5-0.7 | Bullish. Normal market |
| 0.7-1.0 | Neutral to bearish |
| Above 1.0 | Bearish. Hedging demand surging |
Extremely low put/call ratios can signal overheating, while extremely high ratios can be contrarian buy signals.
Implied Volatility (IV)
The market's expectation of future price volatility embedded in option prices. Covered in detail in Options Greeks.
Summary
Options are contracts that trade the right to buy or sell an asset at a specific price. The maximum loss for buyers is limited to the premium, making risk more controlled than futures, but time decay is an inherent cost. Various strategies are possible, from protective puts to hedge spot holdings against downside risk, to covered calls for generating additional yield in ranging markets. The put/call ratio serves as a supplementary indicator of market sentiment.
Next article: Options Greeks - Understanding Delta, Gamma, Theta, and Vega