Cryptocurrencies have had a volatile ride over the last couple of weeks. The total crypto market cap plummeted from $2.6 trillion to $1.3 trillion in just 11 days and then recovered to $1.6 trillion.
In the case of Bitcoin, it suffered a one-day drop of 30% on Wednesday, May 12, whilst other cryptos lost between 30-70% of their value in just two weeks.
Has the bull run come to an end?
Investors are concerned about China’s decision to ban Bitcoin mining. Beijing has pledged to “crackdown on Bitcoin mining and trading behaviour” to control financial risks. Miners in China are anticipated to halt their operations. That would be a major setback since almost 75% of the world’s Bitcoin is mined in China alone.
Some analysts think Crypto prices could get hammered further in the short-term, especially as miners feel the pressure to sell crypto held on their balance sheets.
Joseph Edwards, head of research at crypto brokerage firm Enigma Securities, told Reuters, “Nobody’s really sure about what happens next. Crypto clearly finds itself in a tough spot in terms of the narrative right now, and it’s taken a lot of oxygen out of the room.”
Some investors use options to hedge their bets
It’s difficult to know where the market will be next day or next week. But it is easier to figure out the long-term trend despite the regulatory risks. Yes, China and other governments could ban Bitcoin. But China had also banned it in 2013 and again in 2017. The 2021 ban is China’s third attempt.
Depending on where you expect the price of your favourite cryptocurrencies to be in the next year or so, some investors use options to hedge their portfolio against the downside or to benefit from the upside.
What is a Cryptocurrency option?
An option is a derivative contract that gives you the right to buy or sell the underlying crypto asset at a set price (strike price) on or before an expiration date. Remember that the option gives you the right, but not the obligation to buy or sell the asset.
A “call” option is the right to buy the underlying asset. The right to sell the underlying asset is a “put” option. Traders can use the call and put options to reduce the risk at a reasonably low cost.
There are two styles of crypto options:
- American style: Allows you to exercise your right to buy or sell at any time before the expiration date
- European style: Allows you to exercise the contract only at the time of expiry
Though investors can exercise the European-style options only when expiry, they can still trade or sell to someone else. The options can also be closed out early if you want.
You have to pay a “premium” to buy an option. It’s similar to how you pay for insurance.
The premium payable depends on a number of factors, including the current price of the underlying asset, the time remaining on the contract, and the expected volatility.
The current price of the asset is the single biggest factor in determining the premium. It could be In the money, At the money, or Out of the money.
- In the money (ITM): For a call option, ITM means the strike price is lower than the asset’s current price. For a put option, it means the strike price is above the current price.
- At the money (ATM): For both call and put options, ATM is when the strike price is equal to the current market price of the underlying asset.
- Out of the money (OTM): The strike price is above the current price for a call option. For put options, OTM means the strike price is below the current price.
How to write and trade options
We’ll use an example to make it easier for you to understand. Every options contract has a strike price and an expiration date.
Let’s say you want to trade options on Premia Finance, a decentralized protocol that supports call and put options for a variety of native Ethereum and Binance Smart Chain tokens. It lets you easily write, exercise and trade options for a variety of supported assets.
You have the freedom to create and trade options of any strike price, any expiration date, and any token supported on the platform.
To create an option, head over to the Premia Finance website, go to the Mint section, and customize the option you’d like to mint.
Next, select whether you’d like to “Mint to Wallet” or “Mint on Sale.” If you choose Mint to Wallet, the options you create will be kept in your wallet. But if you select Mint on Sale, you’ll have to enter a sale price, and the options you created will be listed on the marketplace.
Premia Finance also has a secondary market to facilitate peer-to-peer trades. Anyone can set a bid or ask price for any option on the platform. You can also buy or sell options on the marketplace at the market rate if there is an existing offer for that option. The platform allows users to trade options with others without any centralized system.
Given the short-term volatility and uncertainty in the crypto space, smart traders could use options to minimize the downside risk.