Options 101

The ask price is the amount sellers are willing to receive for an options contract. The ask price is always higher than the bid price. 

The bid price is the amount buyers are willing to pay for an options contract. The bid price is always lower than the ask price. 

As a buyer, the premium is the price to purchase the option, or the total dollar amount the buyer pays. The option premium is the current market price of an option contract.

As a seller, the premium is the price you receive for selling the option. In other words, an option premium is the income received by the seller (writer) of an option contract to another party.

The premium is tied to the value of the contract, as time goes by and the value of BTC/ETH fluctuates up and down, the value of the option is going to fluctuate as well.

*Note: Option premiums on LedgerX are quoted in terms of 1 BTC/ETH, meaning you can trade a fraction of the option premium listed on the options chain.

 

 

The strike price is the price at which the options contract can be exercised. A strike price (or exercise price) is the set price at which a bitcoin option contract can be bought or sold when it is exercised.

For call options, the strike price is where the BTC/ETH can be bought by the option holder. For put options, the strike price is the price at which the BTC/ETH can be sold.

If you’re buying a call, your call is profitable if the value of bitcoin goes above the strike price (plus whatever premium you paid). If the value of bitcoin stays below your strike price, your call option contract will expire worthless. The reverse is true for put options. 

In financial terms, Out of the money (OTM) is a term used to describe an option contract that only contains intrinsic value. As a general rule:

• An out of the money call option will have a strike price that is higher than the market price of bitcoin.
• An out of the money put option has a strike price that is lower than the market price of bitcoin.

An investor wants to buy a call option, choosing a call option with a $10,000 strike price. The option expires in five months and costs $5. This gives the investor the right to buy a bitcoin before the option expires. The total cost of the option is $5. 

Let’s say bitcoin is currently trading at $9,000. When buying the option, there is no reason for the investor to exercise the option because. Otherwise, he would have to pass $10,000 worth of bitcoin when the current market price is $9,000, making a $1,000 loss.

Even though this option would be currently OTM, it doesn’t mean it is worthless yet since the expiration date is in 5 months. The investor simply paid $5 hoping that bitcoin will appreciate above $10,000 within the next five months.

Now, if the option is OTM at expiry date it then becomes worthless. However, prior to expiry, that option will have some extrinsic value which is reflected in the premium (or cost of the option). It could be the case that the price of bitcoin never goes above $10,000 in this example, but the premium of the option might increase to $10, $20, or more if it gets closer to the strike price. In that case the investor would still be able to make some profit by selling the option at a higher premium than he had previously paid for. 

Other two possible scenarios are:

• Bitcoin price moves up to $11,000. The option is now ITM and it is worth exercising. If the investor exercises the call option and sells the option right away, he will be making $995. This is Bitcoin Price - Option Strike Price - Premium = ($11,000 - $10,000 - $5). 
• If Bitcoin price goes up to $10,003, the call option would be in the money but because of the price he paid for the premium, if he was to exercise the option he would still be losing $2. However, if he doesn’t exercise the option, he would lose $5. 

The “intrinsic value” is what we call the amount of an option that is in the money. For instance, let’s say an investor holds a bitcoin call option with a strike price of $10,000. If bitcoin is trading at $10,500 it means that the contract is in the money (ITM). The call option allows the investor to buy a bitcoin for $10,000 and immediately sell it for $10,500, making $500 profit. As a general rule:

• An in the money call option means the bitcoin option holder has the opportunity to buy bitcoin below its current market price.
• An in the money put option means the bitcoin option holder can sell the bitcoin above its current market price.

Note that if the same investor had paid a premium of $550 for the call option, although the option would still be in the money the investor would be losing $50 if the option was exercised given the premium paid. Hence, when an option is in the money it does not necessarily mean that a trader is making a profit.

In financial markets, the implied volatility represents the likelihood of changes in a given asset price. It is used to predict upcoming changes in supply and demand, and consequently to price options contracts.

Option’s price is made up of two main components: intrinsic value and time value. Intrinsic value accounts for the value of bitcoin, while time value is the risk premium that sellers require to provide the option buyer with the right to buy/sell an option up to the expiration date. You could think about it as the “insurance” of the option. The closer an option is to expiring, the less time value the option will have. Conversely, the further away an option is to expiring, the more value the option will have and would make the contract trade at a higher price.

Intrinsic value accounts for the value of bitcoin. If an option has intrinsic value, it is in the money (ITM).

A call option is a contract that gives the holder the right, but not the obligation, to buy bitcoin at a specified strike price at a specified expiration. The buyer pays a premium to the seller for this right.

• Investors may purchase a call option because they believe the price of bitcoin will increase and benefit from an increase in bitcoin price above the strike price.
• Investors may sell a call option to collect premium or because they believe Bitcoin will decline in value or not appreciate above the strike price.

Example: You think the price of Bitcoin is going up. You could buy a call option.

Buying a call option gives you the right to purchase bitcoin from the option seller for the strike price.

You buy one call option at a strike price of $10,000 with a premium of $1,000 that expires in six months. The premium is the cost to purchase the call option.

To buy the option, you need to fund your 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 call position.

Fast forward six months to expiration of the contract and the current market price of bitcoin is $12,000. Six months ago, you paid for the right to buy bitcoin at $10,000. To exercise your option, you will need to fund your account with $10,000 (the strike price).

You have now purchased one bitcoin at $10,000 when the market price for Bitcoin is $12,000, giving you a profit of $1,000 ($2,000 gain if you were to sell the one bitcoin you buy at market price less the $1,000 premium you paid for the option).

Fast forward six months to expiration of the contract and the current market price of bitcoin is $9,000. Your call option will expire worthless and you will have lost the $1,000 in the option premium you paid six months earlier.

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: You think the price of Bitcoin is going down. You could buy to open a put position. Buying a put option gives you the right to sell Bitcoin to the option seller for the strike price.

You buy one put option at a strike price of $10,000 with a premium of $1,000 that expires in six months. The premium is the cost to purchase the put option.

To buy the option, you will need to fund your 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.

Fast forward six months to expiration of the contract and the current market price of bitcoin is $8,000. Six months ago, you paid for the right to sell bitcoin at $10,000. To exercise your option, you will need to fund your account with 1 bitcoin.

You have now 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).

Fast forward six months to expiration of the contract and the current market price of bitcoin is $11,000. Your put option will expire worthless and you will have lost the $1,000 in options premium you paid six months earlier.

You can close a long position by selling the number of contracts that you are long. You do not need to post collateral for a short position when selling to close

Example: You are long +1 2020 06-26 Put $25,000. When you bought this contract last month, you paid $170 in premium. As expiration approaches, you decide you want to close the position. 

When selling the contract, enter the BTC mini quantity (1 in this example) and the limit price. You will see the Total Premium Received, or the amount you will receive for selling this option. The Total Locked is an indication of the position-locked collateral. However, you are not required to post short collateral when selling to close a position.

When your trade executes, your position will be 0 and you will receive the USD premium from selling the option.

Steps to close your long position:

1. Click on Positions in the main dashboard (to the right of Open Orders) > click the position you want to close 
2. Click Sell to Close to launch the order form
3. Enter the price you want to receive. The Contracts field is populated with the number of contracts you are long.
4. Review your sell order. You will see the Premium or the amount you will receive for selling this option. (Typically you post close to the current Ask Price)
5. Confirm your order 
6. When your trade executes, your position will be 0 > view in Open Orders until filled 

You can close a short position by buying the number of contracts that you are short. The Position Locked collateral for the short position will be unlocked when you close the position

Example: You are short -1 2020 06-26 Put $25,000. When you sold this contract last month, you received $170 in premium and position locked $250 (the deliverable at expiration). As expiration approaches, you decide you want to close the position. 

• When buying the contract, enter the BTC mini quantity (1 in this example) and the limit price. You will see the Total Premium Paid, or the amount you need to pay to buy this option.
• When your trade executes, your position will be 0 and the $250 position locked collateral for this short put will be unlocked.

Steps to close your short position:

1. Click on My Positions in the main dashboard (to the right of Open Orders)
2. Click the position you want to close
3. Click Buy to Close to launch the order form
4. Enter the price you want to pay. The Contracts field is populated with the number of contracts you are short.
5. Review your buy order. You will see the Total Premium or the amount you need to pay to buy this option.
6. Confirm your order

When your trade executes, your position will be 0 and the position locked collateral for this short position will be unlocked.

Expiration is the last day that an option can be traded. Options expire at 4PM EST on the expiration date. Settlement runs at 5PM ET. On or before the expiration date, market participants must decide what to do with their expiring position. LedgerX contracts are European-style meaning they can only be exercised on the date of expiration. LedgerX does not auto-exercise in-the-money options at expiration.

European Style Options are only exercisable at expiration. All options on LedgerX are European-style. The full contract specifications for LedgerX options are available here.

Physically settled contracts mean that the underlying asset (in this case Bitcoin) will be delivered upon expiration in exchange for USD. All LedgerX contracts are physically settled and there is no settlement index, meaning LedgerXs will not determine if your options are in-the-money or out-the-money at settlement. Exercise is dependent on the user submitting exercise instructions on the platform. 

Futures	Buyers receive bitcoin/ether   Sellers receive US dollars
Options	Call buyers that exercise receive bitcoin/ether; and sellers on the other side receive the strike price in cash   Put buyers that exercise receive cash equal to the strike price, and put sellers receive bitcoin/ether
Swaps	Selling BTC/ETH; receive cash