Trading Bitcoin options is less risky than futures but mind the premium!

The most basic Bitcoin (BTC) options involve purchasing a call that gives the holder the option to purchase the asset at a fixed price on a set date. For this privilege, the buyer simply pays an upfront fee, known as a premium, to the contract seller.

While this is an excellent way to leverage leverage while avoiding the liquidation risk that comes from trading futures contracts. However, this comes at a cost. The option premium will increase in volatile markets, causing the trade to require a further increase in price in order to make a reasonable profit. Hence, the premium is a metric that investors need to watch closely.

Bitcoin 3-day historical volatility. Source: buybitcoinworldwide.com

Bitcoin’s daily volatility is currently 5.4%, well above that of 1.7% of the S&P 500. This creates opportunities for arbitrage desks who like to keep Bitcoins in custody and sell a call option to capture this premium.

Let’s look at a hypothetical trade to see what role the premium plays in the scenario.

The odds of winning this trade are calculated using the Black & Scholes model and the Deribit exchange presents this information as a “Delta”. In short, these are the percent odds for each hit.

March 26th pricing for BTC call options. Source: Deribit.com

According to the graph above, the $ 54,000 strike for March 26th has a 48% chance of occurring under the option pricing model, which sounds reasonable. On the other hand, the $ 58,000 call option has an implied probability of 37%.

With 20 days remaining until March 2021 expires, the chances of Bitcoin price closing above $ 60,000 for the month seem likely given today’s price action. Considering that this call option trades for 0.0548 BTC each time, it costs $ 2,790 when Bitcoin was trading at $ 50,900.

For this call option to be profitable, the BTC price must be $ 60,800. Had this buyer taken a conservative 3-way leverage futures position, the bitcoin price of $ 60,800 would have produced a profit of $ 1,485.

Options markets are a great way to gain leverage, but investors need to take the time to carefully analyze returns before buying bullish calls.

The views and opinions expressed are those of the author only and do not necessarily reflect the views of Cointelegraph. Every investment and trading step is associated with risks. You should do your own research when making a decision.

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