Cryptocurrency trading has become increasingly popular in recent years, with many investors looking to profit from the volatile price movements of digital assets. One way to trade cryptocurrencies is through derivatives, such as futures and options.
Futures contracts are agreements between two parties to buy or sell an asset at a predetermined price on a specified date. On the other hand, options contracts give the holder the right but don’t obligate them to buy or sell an asset at a predetermined price on or before a specified date.
Both types of derivatives have unique advantages and disadvantages. Hence, it is essential to understand the differences between crypto options trading and futures trading.
Options Trading In Crypto
Options trading in crypto is a type of derivative trading that gives the holder the right but doesn’t obligate them to buy or sell a cryptocurrency at a predetermined price on or before a specific date.
In other words, an options contract is an agreement between two parties, the buyer and the seller, where both have the right to buy or sell a certain amount of a cryptocurrency at a specific price (known as the strike price) on or before a particular date (known as the expiration date).
There are two main types of options contracts:
- Call options give the buyer the right to buy a cryptocurrency at the strike price on or before the expiration date.
For example, let’s say that the current price of Bitcoin is $10,000. You believe that the cost of Bitcoin will go up, so you buy a call option with a strike price of $11,000 and an expiration date of one month from now. The premium for the call option is $100.
If Bitcoin’s price rises above $11,000 at the expiration date, you can exercise your option and buy Bitcoin for $11,000. This would give you a profit of $1,000 per Bitcoin (minus the premium you paid for the option).
However, if the price of Bitcoin is below $11,000 at the expiration date, you can let your option expire worthless. In this case, your only loss would be the premium you paid for the option.
- Put options give the buyer the right to sell a cryptocurrency at the strike price on or before the expiration date.
You believe that the price of Bitcoin will go down in the next month. You can buy a put option with a strike price of $20,000 and an expiration date of one month. This means that you have the right, but not the obligation, to sell Bitcoin at $20,000 on or before the expiration date.
If the price of Bitcoin does go down to $20,000 or below, you can exercise your put option and sell Bitcoin at $20,000, even though the market price may be lower. This would allow you to lock in a profit.
However, if the price of Bitcoin remains above $20,000 at the expiration date, your put option will expire worthless. You will lose the premium you paid to buy the option, but you will not lose any more money.
How Does Options Trading Work?
Here is a step-by-step example of how options trading in crypto works:
- Choose a cryptocurrency to trade: Various cryptocurrencies are available for options trading. Some of the most popular options include Bitcoin, Ethereum, and Litecoin.
- Select an options exchange: Several different options exchanges offer crypto options trading. The most popular options exchanges include Deribit, BitMEX, and OKX.
- Decide whether to buy a call or put option: A call option gives you the right to buy a cryptocurrency at a predetermined price on or before a specific date. A put option gives you the right to sell a cryptocurrency at a predetermined price on or before a specific date.
- Choose a strike price: The strike price is when you can buy or sell the cryptocurrency.
- Choose an expiration date: The expiration date is the date on or before which you must exercise your option.
- Pay the premium: The premium is the price you will pay for the option. Many factors, including the current price of the cryptocurrency, the strike price, the time to expiration, and the implied volatility of the cryptocurrency, determine the premium.
Future Trading In Crypto
Crypto futures trading is a type of derivative contract that allows you to speculate on the future price of a cryptocurrency. Unlike spot trading, where you buy and sell cryptocurrencies at the current market price, futures contracts allow you to agree to buy or sell a cryptocurrency at a predetermined price on a future date.
Crypto futures trading is a popular way to gain exposure to cryptocurrencies without owning them. This can benefit you looking to speculate on a cryptocurrency’s future price without worrying about storing or managing the cryptocurrency.
How Does Future Trading Work?
Crypto futures trading works by allowing two parties to agree to buy or sell a cryptocurrency at a predetermined price on a future date. The two parties to the contract are the buyer and the seller.
- The contract buyer agrees to buy the cryptocurrency at the agreed-upon price on a future date.
- The contract seller agrees to sell the cryptocurrency at the agreed-upon price on a future date.
The price at which the cryptocurrency is bought or sold is called the strike price. The date on which the contract is settled is called the expiration date.
For example, let’s say that the current price of Bitcoin is $10,000. A trader believes that the cost of Bitcoin will be $12,000 in one month. The trader enters a futures contract to buy Bitcoin at $12,000 in one month.
If the price of Bitcoin is $12,000 in one month, the buyer of the contract will buy Bitcoin from the seller for $12,000. The buyer will make a profit of $2,000 per Bitcoin.
If the price of Bitcoin is lower than $12,000 in one month, the contract buyer will still be obligated to buy Bitcoin from the seller for $12,000. The buyer will make a loss of the difference between the strike price and the market price.
Comparison Between Futures Trading And Option Trading
Now that you have a good understanding of the fundamentals of both options vs futures trading let’s start by exploring the similarities between these two trading methods:
Futures Vs Options Trading In Crypto: Similarities
Crypto futures and crypto options trading are derivative financial instruments in the cryptocurrency market. While they have distinct characteristics, there are some similarities between these two trading methods:
Aspects | Similarities |
Derivatives Markets | Both crypto futures and options are part of the broader derivatives market, where the instrument’s value is derived from the underlying cryptocurrency asset. |
Speculation | Depending on your trading strategy, you can use futures and options to speculate on the price movements of cryptocurrencies. You can also profit from rising and falling markets. |
Leverage | Both futures and options offer leverage, allowing you to control more prominent positions with less capital. This can amplify profits but also increase the risk of significant losses. |
Risk Management | You can use both futures and options for risk management. You can implement strategies like stop-loss orders and options contracts with defined risk profiles to protect your capital. |
Flexibility | Both futures and options provide flexibility in trading. You can choose from various contract types and expiration dates to suit your trading objectives. |
Options Vs Futures Trading In Crypto: Differences
Crypto futures trading and crypto options trading are distinct derivatives markets within the cryptocurrency space. Here are the key differences between these two types of trading:
Aspect | Crypto Futures Trading | Crypto Options Trading |
Contractual Obligation | Legally binding obligation to buy or sell an underlying asset at a predetermined price on a future date. Both parties must fulfil the contract terms. | Gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before a future date. The buyer is not obligated to exercise the option if it is not profitable. |
Profit and Loss Potential | Unlimited profit or loss potential. Profit if the price moves in your favour; unlimited loss if it moves against you. | Limited profit potential to the premium paid for the option. Loss potential is also restricted to the premium paid. |
Margin Requirements | Traded on margin, requiring a small percentage of the contract value to trade. Allows control of a large position with little capital. | Typically not traded on margin. Requires the total value of the option contract in the account to trade. |
Exercise and Expiration | They must be exercised on the expiration date, or they will expire worthless. | You can exercise it at any time on or before the expiration date. If not exercised, it expires worthless. |
Hedging and Speculation | Used for both hedging (to reduce risk) and speculation (to profit from price movements). | Primarily used for speculation but can be used for hedging in some cases. |
Factors To Consider When Choosing Options Vs Futures Trading
When choosing between options trading vs futures trading in the cryptocurrency market, there are several factors to consider to make an informed decision, such as:
Risk Tolerance
Futures contracts are a riskier investment than options contracts. This is because futures contracts are legally binding obligations. Options contracts give the buyer the right, but not the obligation, to buy or sell an underlying asset. You may prefer to trade options if you have a lower risk tolerance.
Investment Goals
Futures contracts can be used for both hedging and speculation. Options contracts are primarily used for speculation. If you want to hedge risk, you may prefer to trade futures, but if you want to speculate on price movements, you may prefer to trade options.
Time Horizon
Futures contracts typically have a shorter time horizon than options contracts. This is because futures contracts must be exercised on the expiration date. Options contracts can be exercised at any time on or before the expiration date.
You may prefer to trade futures if you want to make short-term trades. Alternatively, options are a good option if you want to make longer-term trades.
Capital Requirements
Futures contracts are traded on margin, meaning you only need to deposit a small percentage of the contract value to trade. Options contracts are typically not traded on margin. This means you must have the total value of the option contract in your account to trade. Hence, you may prefer to trade futures if you have limited capital.
Conclusion
When it comes to the world of cryptocurrency trading, options vs futures trading offers unique opportunities and advantages. Crypto options trading allows you to hedge your positions, generate income, and manage risk effectively. In contrast, crypto futures trading allows for more straightforward speculation on the price movements of digital assets.
However, crypto trading may attract taxes based on your country. Although you can manually calculate such taxes, it can be a time-consuming process. Hence, you can use KoinX, an automated crypto tax calculating platform, which offers many features such as accurate tax reports, auto-classification of crypto transactions based on their nature, and spam token filtration.
So join KoinX today to simplify your crypto tax process.
Frequently Asked Questions
Which Trading Method Offers More Flexibility?
Options trading is generally more flexible as it allows you to choose whether or not to exercise the contract.
Can Options Be Used For Hedging Risk?
Yes, options are commonly used for hedging, allowing you to protect your positions from adverse price movements.
How Do Potential Losses Differ In Futures And Options Trading?
In futures trading, potential losses can be unlimited, while in options trading, the maximum loss is limited to the premium paid for the option.
Which Trading Method Typically Requires A Higher Initial Investment?
Futures trading usually requires a higher initial investment because of the margin requirements.
