An Option is a right to choose whether the transaction will be done in the future. An Options contract is an agreement that gives the right to the buyer (the holder of the Option) who should pay a premium to the seller (the writer of the Option) to buy or sell an underlying asset at a specified strike price prior to or on a specified date. And the seller who receives the premium is obliged to sell or buy the underlying asset at a specified strike price on a specified date. Unlike futures, the buyer of the Options contract is under no obligation in regards to the trade.
Elements of Options Contract
An Options contract is a financial derivative that can trade various underlying assets, including cryptocurrency. An Options contract can be used to hedge blockchain trading and speculate to gain profits. The elements of an Options contract include:
Underlying Assets: such as Bitcoin;
Contract Size: the amount of the contracts;
Expiration Date: the expiration date of the contract
Strike Price: the price of the underlying asset that is bought or sold by the holders;
Premium: the price of the option contract; the fee paid by the buyer to gain the trading right from the seller, which is the maximum loss of the buyer and the maximum profits of the seller
Types
According to the Option rights:
Call Option
Put Option
According to the relationship between the strike price and the underlying asset’s price:
In-the-Money
At-the-Money
Out-of-the-Money
According to the time to exercise the option:
European Option-an aption that may only be exercised on expiry.
American Option-an option that may be exercised on any trading day on or before expiration.
Call Option and Put Option
Call Options give the holder the right but not the obligation to buy something at a specific price or a specific time period. Hence, the investors who anticipate a rise in the price of the asset would buy Call Options. Supposing that investor A anticipates a rising price of the Bitcoin in a future week, A can pay a Call Option of Bitcoin with the premium and buy the Bitcoin at the current price a week later. If the Bitcoin price soars after a week, A can buy Bitcoin at a price that is lower than the market price so that A gain profits from the spread. On the contrary, if the Bitcoin price drops after a week, A can abstain from the Option to avoid severe loss. Then A will lose nothing but the premium.
S=Market Price, K=Strike Price, C=Premium
As the above graph shows, the break-even point of the Call Option=Market Price-Strike Price-Premium. The buyer has potentially unlimited profits and a limited loss that equals the price of the premium. On the contrary, the seller has a potentially unlimited loss and limited profits that equals the price of the premium.
Put Options give the holder the right but not the obligation to sell something at a specific price or a specific time period. Hence, the investors who anticipate a decrease in the price of the asset would buy Put Options. Supposing that investor B anticipates a decreasing price of Bitcoin in a future week, B can pay a Put Option of Bitcoin with the premium and sell Bitcoin at the current price a week later. If the Bitcoin price drops after a week, B can sell Bitcoin at a price that is higher than the market price so that B gains profit from the spread. On the contrary, if the Bitcoin price soars after a week, B can abstain from the Option to avoid severe loss. Then B will lose nothing but the premium.
S=Market Price, K=Strike Price, P=Premium
As the above graph shows, the break-even point of the Put Option=Strike Price-Market Price-Premium. The buyer has potentially unlimited profits and a limited loss that equals the price of the premium. On the contrary, the seller has a potentially unlimited loss and limited profits that equals the price of the premium.
In-the-Money, At-the-Money and Out-of-the-Money
According to the relationship between market price and the strike price, In-the-Money, At-the-Money and Out-of-the-Money can be classified as follows:
Types
The Relationship between the Market price S and the Strike Price K
Classification
Call Option
S>K
In-the-Money
S<K
Out-of-the-Money
S=K
At-the-Money
Put Option
S<K
In-the-Money
S>K
Out-of-the-Money
S=K
At-the-Money
An Out-of-the-Money Call Option will have a strike price that is higher than the market price of the underlying asset. For example, if A has a BTC Call Option with a strike price of 12,000 dollars, and the current market price of BTC is 10,000 dollars, so A has a right to buy BTC for 12,000 dollars at the expiration date. However, following the reality, A won’t buy the BTC at a price that is higher than the market price to avoid the heavy loss.
Greek — An Indicator to Represent the Sensitivity of the Options Contract Price
There are plenty of factors affecting the price of the Options contract, including the current price of the underlying asset, strike price, the length of the time to exercise the Option and relevant market volatility, which make it difficult to assess the price of the Option. Therefore, Greek letters are introduced to help analyze the options price and risks.
Delta（δ）
Delta, with a range between -1 and 1, represents the rate of change between the Option’s price and a change in the underlying asset’s price. For instance, 0.7 of the delta means when the underlying asset’s price rises by 10 dollars, the Option’s price, theoretically, rises by 7 dollars,
Gamma（γ）
Gamma（γ）represents the rate of change between an Option’s delta and the underlying asset’s price, reflecting the sensitivity of delta towards the market price. Formula: the change of delta/the change of the underlying asset’s price. The Gamma（γ）of At-the-Money is the largest, while the Gamma（γ）of In-the-Money or Out-of-the-Money closes to zero.
Vega（ν）
Vega（ν）represents the rate of change between an Option’s value and the underlying asset’s implied volatility. When the rate of change increases, the Option price grows.
Theta（θ）
Theta（θ）represents the rate of change between the Option price and time. Theta will increase as the expiration time comes closer.
Rho (ϱ)
Rho represents the rate of change between an Option’s value and risk-free interest rate.
Conclusion
The future contract has more flexible trading procedures supporting various investment combinations and strategies to effectively hedge the market risk. For the holder, an Option is equivalent to super leverage with unlimited profits, limited loss and controllable risk. The writer can gain profits from a rising price, decreasing price or stable price, but the risk is too high to estimate.
An Option is easily affected by market liquidity since a market with low fluidity will weaken the interests of the investors to trade. Compared to spot trading, the price of the Option is affected by many complex factors. Hence, investors should be well equipped with relevant investment knowledge and should be able to estimate the potential risks before trading an Options contract.
