Options 101: Options – A Powerful Tool in Crypto Trading

Options in Crypto Trading

Options is a type of derivative contract that gives holders the right, but not the obligation, to buy or sell a quantity of an underlying asset at a predetermined price (called strike price) on a predetermined future date (called expiry date). The amount of money paid to get options is called premium.

There are 2 types of options: call options and put options. Call options give holders the right to buy assets at strike prices on expiry dates, and put options give holders the right to sell assets at strike prices on expiry dates. 

Now, learn and remember the key terms: strike price, expiry date, call options, put options – before we start the paper trading below.

Scenario 1: Now BTC price is $90k. You, somehow, anticipate that it will climb to $100k on Jun 30. What should you do? Consider the following two choices:

• Buy put options for 1 BTC at strike price $95k, expiry date on Jun 30, paying $2k premium 
• Buy call options for 1 BTC at strike price $95k,  expiry date on Jun 30, paying $2k premium

If you buy put options, you have the right to sell 1 BTC at $95k when the price is $100k, which you definitely wouldn’t. In this case, your options are “out-of-the-money” (OTM), or “worthless” and you don’t “exercise” the options. You lose $2k for the premium.

If you buy call options, you are allowed to buy 1 BTC at $95k, when its price is $100k. Assume you sell BTC immediately when you receive it, you get $5k. In this case, your options are “in-the-money” (ITM), and you exercise the option. Your profit is $3k ($5k minus the premium).

Scenario 2: Now BTC price is $90k. You, somehow, anticipate that it will go down to $80k on Jun 30. What should you do? How much do you gain or lose in each case?

• Buy put options for 1 BTC at strike price $95k, expiry date on Jun 30, paying $2k premium 
• Buy call options for 1 BTC at strike price $95k,  expiry date on Jun 30, paying $2k premium

Check the answer at the end of this blog. 

Scenario 3: Not only can you buy options, but you can also sell them too! Take a look at this scenario.

The current BTC price is $85k. You anticipate that BTC will rise to $95k by July 31.

What should you do? Consider the following two choices:

• Sell put options for 1 BTC at a strike price of $90k, with an expiry date of July 31, receiving a $3k premium.
• Sell call options for 1 BTC at a strike price of $90k, with an expiry date of July 31, receiving a $3k premium.

If you sell put options, you’re obligated to buy 1 BTC at $90k if the buyer exercises. If BTC is $95k on July 31, the put is out-of-the-money (OTM) (strike $90k < market $95k), so the buyer doesn’t exercise. You keep the $3k premium with no further obligation.

If you sell call options, you’re obligated to sell 1 BTC at $90k if the buyer exercises. If BTC is $95k, the call is in-the-money (ITM). The buyer exercises, so you must buy 1 BTC at $95k (market price) and sell it at $90k (strike price), losing $5k. After adding the $3k premium, your net loss is $2k.

Trade Cryptocurrencies with Options

Options were initially born for hedging, but with the development of pricing models, traders can speculate options for profit. Take a moment, imagine you are holding a token with different expectations (the token price goes up, down or sideway) – what would you do with options?

Below are some common basic strategies for hedging in different cases. 

1. Protective Put (Hedging a Long Position)

Purpose: Protect the value of crypto you own against a price decline.

How it works: Buy a put option on the crypto you hold. If the price drops, the put allows you to sell at the strike price, limiting losses. If the price rises, you only lose the premium but keep the upside.

Example:

• Scenario: You own 1 BTC at $60,000 and worry about a crash in the next month.
• Action: Buy a put option for 1 BTC with a strike price of $55,000, expiring in 30 days, for a $2,000 premium.
• Outcomes:
• BTC drops to $50,000: Exercise the put to sell 1 BTC at $55,000, limiting your loss to $5,000 (from $60,000 to $55,000) plus the $2,000 premium ($7,000 total loss). Without the put, you’d lose $10,000 ($60,000 to $50,000).
• BTC rises to $65,000: Don’t exercise the put. Your BTC gains $5,000 in value, but you lose the $2,000 premium, netting a $3,000 gain.

Why use it?: Acts like insurance for your BTC, capping losses while allowing unlimited upside (minus the premium).

When to use: You’re bullish long-term but want short-term protection (e.g., during volatile events like ETF approvals).

2. Covered Call (Hedging with Income)

Purpose: Generate income to offset potential losses in a stagnant or slightly declining market.

How it works: Sell a call option on crypto you own. You collect the premium upfront, which cushions losses if the price drops. If the price stays below the strike, you keep the premium; if it rises, you may sell at the strike but cap your upside.

Example:

• Scenario: You own 10 ETH at $4,000 each ($40,000 total) and expect sideways or slight downward movement.
• Action: Sell a covered call option for 10 ETH with a strike price of $4,500, expiring in 30 days, collecting a $2,000 premium ($200 per ETH).
• Outcomes:
• ETH drops to $3,500: The call expires worthless (ETH price < strike). You keep the $2,000 premium, offsetting your $5,000 loss ($40,000 to $35,000) to a net $3,000 loss.
• ETH rises to $5,000: The buyer exercises, and you sell 10 ETH at $4,500 ($45,000 total). You gain $5,000 ($45,000 – $40,000) plus the $2,000 premium, but miss out on extra gains above $4,500.

Why use it?: The premium provides a buffer against small price drops or stagnant markets, but limits upside if the price surges.

When to use: You’re neutral or slightly bearish but want to hold your crypto long-term.

3. Collar Strategy (Protective Put + Covered Call)

Purpose: Hedge with limited cost by combining a protective put and a covered call.

How it works: Buy a put to protect against declines and sell a call to offset the put’s premium. This creates a range where your losses and gains are capped.

Example:

• Scenario: You own 1 BTC at $60,000 and want low-cost protection.
• Action:
• Buy a put for 1 BTC with a strike price of $55,000, paying a $2,000 premium.
• Sell a call for 1 BTC with a strike price of $65,000, collecting a $2,000 premium (nets to $0 cost).
• Outcomes:
• BTC drops to $50,000: Exercise the put to sell at $55,000, limiting your loss to $5,000 ($60,000 – $55,000). The call expires worthless.
• BTC rises to $70,000: The call is exercised, forcing you to sell at $65,000, capping your gain at $5,000 ($65,000 – $60,000). The put expires worthless.
• BTC stays between $55,000-$65,000: Both options expire worthless, and you keep your BTC with no net cost.

Why use it?: Provides downside protection at little to no cost but caps your upside.

When to use: You want to hold crypto but need protection during uncertain market conditions.

4. Protective Call (Hedging a Short Position)

Purpose: Protect against losses if you’ve shorted crypto and the price rises.

How it works: Buy a call option to limit losses on a short position. If the price spikes, you exercise the call to buy at the strike price, covering your short.

Example:

• Scenario: You shorted 10 ETH at $4,000 ($40,000 borrowed and sold), expecting a drop, but worry about a rally.
• Action: Buy a call option for 10 ETH with a strike price of $4,500, paying a $2,000 premium ($200 per ETH).
• Outcomes:
• ETH rises to $5,000: Your short loses $10,000 ($50,000 to buy back – $40,000 short price). Exercise the call to buy 10 ETH at $4,500 ($45,000), limiting your loss to $5,000 plus the $2,000 premium ($7,000 total loss).
• ETH drops to $3,500: Your short gains $5,000 ($40,000 – $35,000). The call expires worthless, so you lose the $2,000 premium, netting a $3,000 gain.

Why use it?: Caps losses on a short position while allowing profits if the price falls.

When to use: You’re bearish but want protection against unexpected price surges.

Conclusion

Crypto options empower traders to thrive in the dynamic crypto market, offering tools like calls, puts, and premiums to manage risk and seize opportunities. By understanding these fundamentals and pricing models like Black-Scholes, you’re equipped to explore strategies for speculation, hedging, or income generation. But how much is a suitable premium to pay, and what are the best ways to generate income or profit with options? Dive into these questions and more in the next parts of our series, starting with Part 2: Advanced strategies with Options!

Solution for exercise

Scenario 2:

1. Buy Put Options

Action: You buy put options, giving you the right to sell 1 BTC at $95k on June 30.

Outcome on June 30: BTC price is $80k as anticipated.

Exercise Decision: Since the strike price ($95k) is higher than the market price ($80k), the put option is in-the-money (ITM). You exercise the option.

You buy 1 BTC at the market price of $80k and sell it at the strike price of $95k.

Gross profit: $95k – $80k = $15k.

Net profit: Gross profit minus the premium = $15k – $2k = $13k gain.

If You Don’t Exercise: If you choose not to exercise, you lose the premium paid.

Loss: $2k (the premium).

2. Buy Call Options

Action: You buy call options, giving you the right to buy 1 BTC at $95k on June 30.

Outcome on June 30: BTC price is $80k.

Exercise Decision: Since the strike price ($95k) is higher than the market price ($80k), the call option is out-of-the-money (OTM) and worthless. You do not exercise the option.

Loss: $2k (the premium paid).

If You Exercise (Hypothetical): If you were to exercise (which makes no sense economically), you’d buy 1 BTC at $95k and sell it at $80k, incurring a $15k loss minus the $2k premium, but since no rational investor would exercise an OTM call, this doesn’t apply.