What is a Put Option
A put option is a contract that gives the holder the right, but not the obligation, to sell one Bitcoin at a specified Strike price at a specified Expiration. The buyer pays a premium to a seller for this right.
- Investors may purchase a put option because they believe the price of Bitcoin will decrease and want to benefit from a decrease in the price of Bitcoin below the Strike price. Put options are often used to hedge the negative impact of declines in the price of Bitcoin.
- Investors may sell a put option to collect premium or because they believe Bitcoin will increase in value or not decline below the Strike price.
Example: Let’s say you think the price of Bitcoin is going down. In this example, you would buy to open a put position. Buying a put option gives you the right to sell Bitcoin to the option seller for the agreed-upon strike price.
In our example you buy one put option, at a strike price of $10,000 with a premium of $1,000 (cost to purchase the put option) that expires in six months. In order to purchase this contract, you will need to fund your LedgerX account with $1,000. Upon executing the trade, the $1,000 will be transferred from your account to the seller’s account and you will now hold one open put position.
If we fast forward six months to expiration of the contract, we see that Bitcoin is trading at $8,000. You will be able to exercise your put option by funding your account with 1 Bitcoin. You have now essentially sold one Bitcoin at $10,000 when the market price for Bitcoin is $8,000 giving you a profit of $1,000 factoring in the premium you paid for the option.
If at expiration of the contract Bitcoin is trading at $11,000, your put option will expire worthless and you will have lost the $1,000 in option premium you paid six months earlier.