As cryptocurrency is developing and integrating with the traditional financial market, the crypto derivatives market is becoming increasingly popular. Futures are taking the lead in crypto derivatives, but there is also another instrument with similar trading fundamentals — options.
Options on Ethereum allow traders to gain exposure to ETH, without directly purchasing the asset. The ETH option holder can earn profit either when the price of the underlying asset rises or when it falls. This article explores the features of options on ETH and other related questions!
- Options are agreements between a buyer and the seller, which give the buyer the right to buy or sell the asset at a certain price until a set date
- Just like futures, options allow profiting not only on the rising, but also on the falling market
- The price that the options can be exercise is called a “strike price”
- If the current price is better than the strike price, the option is “in the money”, but if it is worse — then the option is “out of money”
Ethereum: A Short History
The reader may have a fair question as to why we are looking at options on Ethereum when there is a huge number of other assets. The answer is simple: Ethereum is the second cryptocurrency in terms of market capitalization, with a relatively long history and a proven track record of reliability.
Ethereum is an open-source software platform based on blockchain technology. This platform allows developers to create and deploy decentralized applications (dApps). Its story began in 2013, when Vitalik Buterin, a Russian-Canadian programmer (and co-founder of Bitcoin Magazine), released a white paper describing the new blockchain. The project was launched in test mode in the summer of 2015, and nine months later a Homestead release was presented to run at full power.
Ethereum became a pioneer in smart contracts and gave a start to the development of the decentralized finance industry. At the moment, ETH accounts for almost 60% TVL of the entire DeFi industry.
Since its launch, Ethereum has risen to #2 in the CoinMarketCap cryptocurrency rankings and has managed to maintain its position ever since. As of January 30, 2023, its market capitalization is about $192 billion.
What Are Options
An option is a contract that gives an investor the right (but not the obligation) to buy or sell the underlying asset within a specified period, at a set price. As the buyer of the option has no obligation, they therefore may choose not to exercise the option if the conditions are not favorable. This feature distinguishes options from futures contracts, which are the obligations to buy or sell an asset before expiration.
Investors use options for speculation and short-term transactions, because options have a high return potential with a limited loss. Once you buy an option, you cannot lose more than the option premium (paid to the seller of the option). At the same time, options allow you to earn both on the upward and downward trends.
What Are Ethereum (ETH) Options
Cryptocurrency options provide their holder the right to buy or sell the underlying digital asset. In case of ETH options, the underlying asset is Ethereum. An option on ETH is based on the price index of 1 ETH (average from several sources), most often expressed in USD.
There are two types of options: CALL and PUT.
- CALL is the obligation of the seller of the option to sell the asset, and the buyer the right to buy;
- PUT is the obligation of the seller of the option to buy and the buyer to sell.
It is important to note that options are asymmetrical contracts. Because one side of the contract has an obligation and the other has a right. Since the obligation itself is a risk, the buyer pays a premium (option price) to the seller to cover that risk. The seller receives the premium payment immediately upon the sale of the option, while obligations should be fulfilled by them at some point in the future.
Basics of Option Trading
Although options trading may seem risky or challenging to novice investors, some basic strategies using options can help to protect the current investments and hedge market risk.
There are several basic options trading strategies:
- Long Call: used if the trader expects the price of the underlying asset to rise. The stronger is the increase, the larger is the profit of the buyer;
- Long Put: used if a trader predicts that the prices will fall;
- Short Put/Short Call: The seller gets the premium, but risks to lose the money in case price goes in the opposite direction. Most often used for hedging purposes. For example, an ETH validator placing Ethereum call options receives guaranteed income in the form of a premium. Even if they have to pay the buyer in the future, that loss will be offset by the profit from selling the coins at a higher price.
Ethereum Options Trading
As stated above, options can be not only bought (Long) but also sold (Short). However, it should be stressed that selling options on ETH is much riskier. The risk can be explained: the buyer of the option can cancel the deal if it is not profitable for them, but if the price suddenly goes against the seller of the option, they will not be able to avoid selling at a loss. In any case, it is better to use limit orders in transactions to reduce the risks.
That said, the ETH options market is quite volatile. As with other asset classes, traders have a better chance of making a profit if the market moves in their favor.
ETH Options vs. Ethereum
It is important to understand that there is a significant difference between buying ETH coins directly and buying options on ETH.
So when buying options on Ethereum, you gain the following advantages:
- Limited losses (no more than the size of the option premium). At the same time, the maximum return is not limited and depends only on the final price of the asset;
- Fixed settlement terms;
- No slippage (possible loss does not depend on the volatility of the market);
- Possibility to use leverage. Margin derivatives are available on many exchanges.
However, by buying Ethereum coins directly, you also get a number of advantages that are not available when trading options:
- Buying coins on the spot market is extremely easy and more suitable for beginners;
- The owner of ETH coins can expect to earn passive income by depositing the coins into staking;
- ETH coins can be used to pay commissions when using decentralized projects on the Ethereum blockchain;
- When forks of the Ethereum network are created, coin owners usually automatically receive new coins, as was the case with the recent Ethereum PoW fork.
Buying Ethereum Options
The main trading venues for buying ETH options are centralized exchanges such as Deribit or OKX Futures. However, before you start trading options, you need to familiarize yourself with the basic concepts and terms inherent in this market.
Options belong to the class of futures products. That is, there is a specific moment in time, down to the second, when the option will be exercised (with or without profit). This time is called the expiration date. After the expiration date, the option ceases to exist.
Crypto markets have a special calendar with the option expiration dates. There are, for example, one-day, one-week and two-week options.
The strike price is an important component of an option. In essence, it is the estimated price of the underlying asset at which the trade will be executed. For example, an option with a strike price of 2,000 is an obligation for the seller of the call option to sell you 1 ETH at 2,000, and for the buyer, the right to agree to the deal, or not. These prices are set by the exchange with a certain range depending on the initial value of the asset — 10, 25, 50, 100, 500, 1000, 2000, 5000 and 10 thousand. Neither the buyer nor the seller can choose strike prices arbitrarily, but only from those set by the exchange.
It is critical to understand that the strike price determines the current result for the buyer of the contract in case the contract is immediately executed.
This is why traders and investors use the concept of “moneyness” in options trading. The terms “In the money” and “Out of the money” are used to denote the “moneyness” of contracts.
In the Money (ITM)
The expression “In the money” means that the price of the underlying asset is currently better than the strike price:
- Above the strike for contracts to buy the underlying asset (call options);
- Below the strike for contracts to sell the underlying asset (put options).
In short, the option is considered ITM when it results in profit when exercised at the current moment. “In the money” contract is also said to have an intrinsic value that the buyer can realize (make a profit). It can be realized not only when the option is exercised, but also when it is sold before the expiration time.
For the seller, this means that by exercising the contract, they incur a loss. The higher the intrinsic value of the option, the greater the seller’s loss.
Out of the Money (OTM)
The term “Out of the money” refers to a situation where the price of the underlying asset for an option turns out to be worse than the strike price:
- Below the strike for call options;
- Higher for put options.
If the buyer refuses to exercise the option, they suffer a limited loss equal to the premium paid to the seller. For the seller, an option “Out of the money” means that they will make a profit equal to the premium at immediate expiration.
It is important to understand that the intrinsic value of the “Out of the money” options equals zero.
At the Money (ATM)
It is also possible that the current price of the underlying asset for a Call or Put contract is exactly equal to the strike price. In this case, the term “At the money” applies.
When the option “At the money” is exercised, the seller makes a profit equal to the value of the premium, while the buyer bears losses of the same amount. The intrinsic value of the contract “At the money”, as in the case of “At the money” is equal to zero.
Despite a slightly greater complexity compared to the simple asset purchasing, or futures trading, options trading are a convenient tool. A particularly significant advantage of options is that buyers do not have to execute the contract if they are not willing to. Thus, the losses are limited to the amount of premium paid.
Options on ETH can be used not only for speculation, but also to hedge risks. However, this instrument is quite complex and is supported only by a few exchanges.
Why Trade ETH Options?
Options, just like other derivatives, help traders to hedge against adverse market movements. The advantage of the options over futures, for example, is that the buyer has no obligation, but only the right to exercise it.
Are ETH Options a Good Investment?
Options cannot be called a tool for investment because they let you purchase a contract, not an asset. It is well suited for speculating on the price of underlying assets and hedging.
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.