What Are Options In Crypto?
Thinking of trading with low risk and cost? Crypto options trading should be your go-to. When compared to other types of CDs like perpetuals and futures, options provide a safer strategy for traders.
Options trading was initially available to only the traditional derivatives market; however, the growth in the crypto ecosystem has led to the rising popularity of options trading in crypto as well.
In crypto, typically an options contract is a form of crypto derivative where the traders (i.e. buyers and sellers) agree on a specific price for an asset to be bought and sold at a specific date. The buyer has the right to, but is not obligated to, buy the underlying asset at the agreed upon price. Of course, vice-versa for selling.
<text-h2>How does options trading work in DeFi?<text-h2>
First, you gotta know there are two different types of options in play here:
Call option: this is your right to buy an underlying asset at the agreed price and date. You’d do this when you expect the price to go up.
Put option: this is your right to sell an underlying asset at the agreed price and date.
Another key thing to note is, there are two styles of options trading: the European style (the contract can only be exercised at the expiry date) and the American style (the contract can be exercised on or before the expiry date).
Now this is how it plays out in crypto: the options seller creates the call and put option contract(s) with a set price (strike price or the price you have the right to buy or sell on or before the expiry date depending on the style of options used) and an expiry date. This is then listed on an exchange or DEX that trades options. Typically, you have to pay a premium which is the cost to buy the option contract.
Need an example? Okay visualize this — at the start of the month of April, an options contract was created to buy a call of 5 ETH at a strike price of $2,000 making it $10,000 for 5 ETH in total. The premium set for the contract is $1,000.
As a bullish trader, let’s say you think by the end of April the price of ETH will increase so you buy the call option on ETH. At the end of April, let’s say the 27th (expiry date) the price of ETH rose to $4,000. The implication is you’ve bought ETH at a cheaper price than the expiration price i.e. initial total for 5 ETH = $10,000 while the expiration price total = $20,000, which means a profit = $10,000 — $1,000 (premium paid) = $9,000.
However, if the price of ETH goes down at the expiration date and you choose not to exercise your right to buy the call, the only “loss” would be the $1000 premium you paid.
The main benefit of options trading and what sets it apart from other forms of CDs is that you are not obligated to exercise the contract at the date of expiration. If the price goes against you after buying a call option, your loss or risk is limited to the premium you paid. This is why many traders opt to trade options: to minimize risks but still gain exposure to upside potential.