Beyond Bitcoin futures, Bitcoin options contracts represent another popular product actively traded by both individual and institutional investors. In fact, according to TokenInsight, options trading volume surged from $8 billion in the first quarter of 2020 to $45 billion in the fourth quarter, culminating in a total annual trading volume of $77.2 billion for the year.
As a result, digital asset options play a significant role in the crypto ecosystem, offering various use cases for traders and investors.
What Are Cryptocurrency Options?
An options contract is a derivative instrument representing an agreement between two parties that facilitates the potential transaction of an underlying asset at a predetermined price—known as the strike price—before the expiration date.
While derivatives can cover various instruments—such as stocks, bonds, commodities, currencies, and market indices—in the case of cryptocurrency options, the underlying asset is Bitcoin (BTC), Ethereum (ETH), or another digital asset.
Digital asset options are very similar to futures contracts since both represent agreements between two parties with a cryptocurrency as the underlying asset.
However, while both the buyer and seller are obligated to fulfill their commitments in a futures contract, the holder of an options contract is not required to execute the transaction at expiration.
The buyer (holder) purchases the option from the seller (writer) for a premium. Even if the buyer chooses not to exercise the right, they still must pay the premium.
The premium price depends on several factors, including the asset’s value, the strike price, volatility, and the time remaining until expiration.
Higher volatility levels increase the premium; shorter time frames typically result in lower premiums. The latter is due to the reduced likelihood of a favorable price movement within a limited period.
Depending on the broker or crypto exchange, options are categorized into two styles: American and European.
American options allow holders to exercise their rights at any point before expiration, while European options are more restrictive, permitting exercise only at expiration.
Like other derivatives, crypto options traders can use leverage, which increases both potential profit and risk. While leverage can amplify gains, highly leveraged positions can also significantly heighten exposure.
Beyond profit potential, traders use crypto options to mitigate price volatility, hedge against market risks, and short digital assets.
How Crypto Options Work
You can trade cryptocurrency options in two forms: calls and puts.
A call option gives the buyer the right to purchase the digital asset at a predetermined strike price, while a put option allows the holder to sell the cryptocurrency at a specified strike price.
Below, we explore four common scenarios in crypto options trading to illustrate how they work in practice.
Buying Call Options
Buying a call option signals bullish sentiment, as the holder anticipates that the underlying digital asset will increase in value in the near future.
By purchasing a call option, the buyer protects themselves against high volatility.
Instead of buying the digital asset on the spot market, the trader uses a call option to hedge their position. As a result, the only risk faced is the premium paid to hold the contract.
If the underlying asset’s value rises significantly above the strike price by expiration, the holder can exercise the right to buy and realize a profit.
Conversely, if the cryptocurrency’s value remains below the strike price, the holder can choose not to execute the trade, limiting the loss to the premium paid.
Buying Put Options
While buying calls reflects bullish sentiment, purchasing a put option indicates that the holder expects the underlying asset’s price to decline.
However, unlike shorting a cryptocurrency, a put option holder is protected against sudden upward price movements.
In this case, the put holder can choose not to exercise the option at expiration, losing only the premium paid.
If the spot price falls below the strike price, the buyer profits by an amount greater than the premium paid for the contract.
Selling Put Options
Interestingly, traders with a bullish outlook can also profit by selling put options.
When the spot value of the cryptocurrency remains above the strike price, the put buyer will likely not exercise the option, allowing the seller to profit from the premium.
Although the premium offers profit potential, unlike the buyer, the seller is obligated to transact the underlying asset if the holder decides to exercise the option before expiration.
Thus, option sellers cannot avoid losses in the same way buyers can, though they still retain the premium income.
Selling Call Options
Similar to buying put options, selling call options allows traders to benefit from bearish price movements.
As with selling puts, the call writer earns a profit from the premium if the buyer does not exercise the right to trade the asset.
However, call sellers profit only if the asset’s spot value remains below the strike price.
Otherwise, they must fulfill the obligation and potentially incur losses.
Top 3 Popular Crypto Options Trading Strategies
One of the key advantages of crypto options is their flexibility, enabling traders to implement a wide range of strategies.
Below, we outline three of the most popular crypto options trading strategies:
Protective Put:
Traders use a protective put strategy when they already hold the underlying asset. To hedge against potential downside price moves, you purchase a put option with a strike price at or near the current value of the digital asset. If the cryptocurrency’s price declines, you can exercise the right to sell at the strike price, covering most of your losses. If the asset’s value rises, you simply let the option expire, losing only the premium.
Covered Call:
A covered call involves selling a call option while holding the underlying digital asset. This allows you to earn extra premium income if the price stays bearish and the buyer doesn’t exercise the option. If the price rises, the loss from the call option is offset by the gains in the held asset—hence the term "covered."
Straddle:
Traders simultaneously purchase a call and a put option with the same strike price and expiration date. While this may seem counterintuitive—since you are betting on both upward and downward price movements—it can be profitable in highly volatile markets. If the price moves significantly in either direction, the gains from one option can exceed the total premium paid for both.
How Options Trading Influences Crypto Markets
Cryptocurrency options trading rarely has a direct impact on the spot price of the underlying crypto.
However, large concentrations of capital in out-of-the-money (OTM) options nearing expiration—calls with strike prices above the spot price and puts with strike prices below—can suddenly increase market volatility and influence the asset’s price.
If overall market sentiment is bullish, call options will dominate.
In bullish scenarios, market makers—those providing liquidity to exchanges—may hedge the OTM call options they sold to buyers by purchasing the underlying asset.
When large volumes of OTM options expire within a short period, this hedging activity can heighten volatility and further drive up the cryptocurrency’s price.
Crypto Options: Significant but Still Emerging Derivatives
Crypto options are growing in popularity but remain in an early stage, especially when compared to the trading volume of digital asset futures.
Despite recording $77.2 billion in volume in 2020, options were overshadowed by futures contracts, which saw $12.31 trillion in volume during the same period.
Cryptocurrency options add diversity to digital asset markets and offer investors multiple use cases, such as hedging market risks and amplifying potential returns through leveraged trading.
To explore real-time tools for monitoring options activity and market trends, consider using this advanced analytics platform.
Frequently Asked Questions
What is the main difference between crypto options and futures?
Crypto options give the holder the right, but not the obligation, to buy or sell an asset at a set price before expiration. Futures contracts obligate both parties to execute the trade at the predetermined price and date.
Can beginners trade cryptocurrency options?
Yes, but it’s important to start with a solid understanding of options strategies and risks. Beginners should use demo accounts, educational resources, and avoid high leverage until they gain experience.
How does volatility affect options pricing?
Higher volatility increases the premium of options because large price swings raise the probability that the option will end up in-the-money by expiration.
What are in-the-money (ITM) and out-of-the-money (OTM) options?
An option is ITM if exercising it would be profitable based on the current market price. It is OTM if exercising would not be profitable.
Is options trading available on all crypto exchanges?
No, not all exchanges offer options trading. This feature is typically available on larger, derivatives-focused platforms.
How can I use options to hedge my crypto portfolio?
You can buy put options to protect against downside risk or sell covered calls to generate income while holding assets. Both strategies help manage risk in volatile markets.