Crypto options are a type of derivatives that are used to buy or sell underlying assets at a predetermined date and price. These are issued by issuers and purchased by traders. Traders can choose not to exercise them. Options are used to hedge for risk and speculate in the market.
Currently, in the crypto market, there are a lot of derivatives that are being used. They have collectively increased the liquidity in the market. Additionally, they have also improved the market equilibrium conditions by providing instruments to exercise arbitrage opportunities. Crypto options are also one such form of derivatives that have made it possible! Let’s dive in and understand how they work and their benefits.
What Are Crypto Options?
Options are a form of derivatives. Derivatives are financial instruments that are used to either hedge or speculate on an asset. Crypto options are a form of options. The core function however remains the same. They allow the buyer of an option the right to buy or sell an asset at a predetermined time and price. There are two types of options available in the market: a call option and a put option. A call option is used to buy and a put option is used to sell an asset when you choose to exercise them. The instrumental difference between futures and options is that you do not have the obligation to exercise options. Futures on the other hand do not give you that liberty.
How do crypto options work?
The process of crypto options is simple at heart. There is an issuer who issues a put and a call option with a strike price and expiry date for some price. The strike price is the value at which the underlying asset can be brought or sold at the time of exercise the option. Now let’s go over a real-life example. Let’s say, a trader buys a put option from an issuer at a strike price of $100 at a cost of $5. The current value of the underlying asset on which the option has been issued is $95.
Therefore, it would not make sense to exercise it just now. If you choose to exercise it just now you will not make any profits. You will sell the asset at $100 and there will be a cost of the option will be $5. Therefore, you get $95 overall. Therefore, you should not exercise it. However, as soon as the price of the asset goes to $85 and earn $10 after exercising the put option.
Similarly, you can exercise the call option if the price of an asset rises above the strike price+ price of the call. Therefore earning you the difference between the price of the asset – strike price – the price of the call option.
Benefits of Crypto Options
In addition to improving the market equilibrium by providing arbitrage opportunities, they also allow users to hedge against risk. They are cost-effective since you do not have to pay an upfront premium while issuing an options contract. Another hidden benefit is that you do not have the exercise the options contract by a compulsion. You can the option of not exercising the contract.
