CoinMarketCap Alexandria 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.
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
Similarities of Crypto Options and Futures
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
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.
Depending on whether you believe an asset will rise or fall in value, you will need either a call or a put option.
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.
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.
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?
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?
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.
What’s the Difference Between Buying and Selling Futures?
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.