CoinMarketCap Academy takes a look at the differences — and similarities — of crypto options and futures.
Options and futures are incredibly useful tools for crypto traders, and they are only becoming more popular.
In fact, the combined trading volume for Bitcoin and Ethereum options last year reached $387 billion.
But how do crypto options and futures contracts actually work? And what’s the difference between them?
This guide explores these questions and more!
The latter part of this guide offers a detailed and thorough explanation of what options and futures are, how they work, and the differences between them.
But first, here’s a short summary for those of you who just want a fast answer.
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A Short Summary
Options and futures are financial products that traders use to generate profit or protect their investments against market volatility.
Similarities of Crypto Options and Futures
Both are derivatives, which means they derive their value from underlying assets like stocks, commodities or, in our case, crypto.
However, neither options nor futures grant you ownership over the underlying asset itself, which is actually considered a benefit because you can profit from price swings in the crypto markets without ever buying any cryptocurrency.
While options and futures share many similarities, they also differ in several important ways.
Differences of Crypto Options and Futures
Options give you a choice – but not an obligation – to either buy or sell a cryptocurrency at a pre-agreed price before a certain date. In exchange for this assurance, you will have to pay a premium when you buy the contract.
Futures, on the other hand, obligate you to buy or sell a cryptocurrency at an agreed price when the contract expires. They do not, however, require you to pay premiums.
Of the two contracts, options are considered comparatively less risky because you have only, as the name suggests, the “option” to buy or sell, and not an obligation.
That’s the short version out the way, so now, let’s dive into a more detailed explanation of how options and futures contracts work.
Diving Deeper into Crypto Options and Futures
Both options and futures provide a useful way for traders to cover their downside and protect against the above-average volatility found in the crypto markets.
Options and futures are somewhat similar, but if you plan on using either of them, it’s important that you know exactly how they differ and when you should use each one.
Let’s get started by exploring crypto options in depth.
What Are Crypto Options?
Options are derivative contracts that give the buyer the right to buy or sell an asset at a set price before an agreed expiration date. When you buy or sell an option for a cryptocurrency, you don’t own the crypto itself. In this way, options allow you to gain exposure to almost any cryptocurrency without actually purchasing it.
Options have an expiry date, which sets out the point at which the contract must be fulfilled, and a strike price, which establishes the price for which the asset may be bought or sold before the option expires.
Crypto options come in two distinct styles: American, where you can exercise the contract at any point before it expires, or European, where you may fulfil it only at the moment it expires. Which option style you need for any given trade mostly depends on how much risk you are willing to accept, and your degree of certainty about the market’s direction.
Depending on whether you believe an asset will rise or fall in value, you will need either a call or a put option.
Call options allow you to buy the underlying asset at a certain price before the contract expires. Calls are profitable when the market rises, but they don’t protect you from downswings.
Put options, on the other hand, let you sell an asset for an agreed price when the contract ends. Puts save you money during market downswings by allowing you to sell an asset at an earlier, higher price.
Whenever you buy an option, you have to pay a premium. You will lose this premium if you don’t exercise the option before it expires. The premium’s price will vary depending on how much time is left on the contract, the underlying asset’s volatility, and the asset’s current price.
How Do Options Work in Practice?
Here’s an example to illustrate how options work.
Let’s imagine that you buy an Ethereum call option at $3,000, expiring in 90 days, with a $300 premium. For clarity, this option allows you to buy Ethereum at $3,000 at any point in the next ninety days. If Ethereum’s price rises to $4,000, you can exercise the contract and take your $1,000 profit minus the $300 premium.
If Ethereum’s price drops below $3,000, you will lose your $300 premium payment, but you aren’t required to buy any Ethereum for less than its true value, so your maximum loss would be the premium you’ve paid, i.e. $300.
Instead, let’s say you bought a 90-day Ethereum put option, also at $3,000 with a $300 premium. In this case, you could sell Ethereum at $3,000 within the following ninety days.
If Ethereum’s price rises to $4,000, you wouldn’t exercise your option, because doing so would incur a $1,000 loss. Instead, you would just let the option expire and lose the $300 premium.
However, if the markets dipped and Ethereum slipped to $1,500, your put option would allow you to sell Ethereum for $3,000, helping you to cover some losses.
Selling Crypto Options
So far we’ve only mentioned about buying options. However, you can also sell options — also known as being an options writer — and collect the premiums paid by buyers.
It’s important to remember that most options sellers own at least some amount of the underlying asset from which their options derive value, which they use to fulfil the option if the markets swing in the wrong direction.
However, when an options seller doesn’t own any of the underlying asset, they create what’s called an “uncovered” or “naked” option, which is considered very risky business.
What Are Naked Crypto Options?
Selling options naked allows you to profit without investing a significant cash sum, but again, doing so is considered an extremely high-risk venture. There’s theoretically no limit to how high a crypto’s price can go, which means your risk from selling naked put options is also potentially unlimited. Typically, options brokers require you to post a certain amount of collateral — known as option margin — before you can sell options.
To illustrate, here’s a covered vs uncovered option example.
Let’s say you sell a 90-day naked call option for Bitcoin at $30,000, which requires you to sell Bitcoin at that price no matter how much its price rises.
If Bitcoin’s price rockets to $40,000 in a day, which it could, you would have to buy Bitcoin at a 33% premium and then sell it to whoever bought your option for $30,000, losing $10,000 in the process.
Whereas if you had covered yourself by buying Bitcoin for $30,000 (or less) before you sold your option, you wouldn’t need to buy any Bitcoin at the higher price. You could have also gained from Bitcoin’s price surge if you had owned more Bitcoin than your option required you to sell.
What Are Crypto Futures?
Futures contracts allow you to buy or sell a specific asset at a later date at a predetermined price. They were invented to smooth out price volatility in food and agriculture markets by allowing farmers to purchase crops or seeds in advance at an agreed price.
Similar to the options contracts we just looked at, futures are linked to, and derive value from, an underlying asset like commodities, stocks or crypto. Also like options, they let you gain exposure to a cryptocurrency without actually purchasing it.
However, whenever two parties enter into a futures contract, the underlying asset must be bought or sold when the contract expires. It is this obligation which makes futures trading inherently riskier than trading options.
What’s the Difference Between Buying and Selling Futures?
When you sell a futures contract, you are obligated to sell an asset at an agreed price on a certain date. So when the market dips, whoever bought your future is legally obligated to buy the asset from you whenever the contract expires.
Whenever you buy a futures contract, you lock in a price in advance. This allows you to profit if the market ticks up, as you will buy the underlying asset for less than it’s worth to then sell it on for a profit.
Also, when you buy a futures contract, you don’t need to stake the entire value of the contract. You can instead hold a percentage of the value required to fulfil the contract, which is called trading on margin.
However, if the asset upon which your futures contract is based happens to drop in value, the exchange from which you purchased your contract might issue what’s called a margin call. If you receive a margin call, you will need to post more money as collateral or risk voiding your contract.
As you can see, by obligating you to buy or sell an asset, futures are inherently riskier than options. But on the plus side, you don’t have to pay premiums or fees upfront to issue a futures contract, so you can turn a profit without putting up any money in advance.
Let’s look at an example to see how futures work.
How Do Futures Work in Practice?
Let’s imagine Bitcoin sits at $30,000, and you want to buy a futures contract to profit from an expected price move.
If you believe Bitcoin’s price will rise, you could buy a futures contract at $30,000, which would obligate you to buy Bitcoin at $30,000.
So if Bitcoin’s price rose to $35,000 when the contract expired, you could buy one Bitcoin for $30,000 and immediately sell it for $35,000, netting a $5,000 profit.
Now let’s imagine you own one Bitcoin, but you believe its price might dip. In this case, you could sell Bitcoin future at $30,000, which would require the person who buys it to pay you $30,000 for your one Bitcoin whenever the contract expires
So if the price fell to, say, $20,000, you would have saved yourself from a $10,000 loss. However, if the price rose to $40,000, you would have to sell your Bitcoin for $10,000 less than it was worth.
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