A Comprehensive Guide To Crypto Options
A Deep-Dive Into Different Crypto Option Strategies
If you want the so-simple-my-grandma-could-do-it guide to shorting crypto, check this out. This is not that.
I wrote this article because I want to try to help cement a really strong understanding of how options work. Once you get it, it becomes very intuitive and it’s pretty easy to understand how to use them in your portfolio.
The Index:
What Are Options? Deep Dive
Conceptually, I think there are two valuable ways to think about options:
It is basically like betting on the market. Just like with betting, you have odds. You make a bet by buying a Call or a Put and deciding the strike price of the asset on a future date. A Call lets you sell the asset at the strike price on that date and a Put lets you buy the asset. The lower the odds of winning, the less money it costs to make the bet.
They are kind of like insurance. For a little bit of money, you could get a lot of money in the unlikely event of a disaster. If the event is more likely, the insurance will cost more money.
Options, imo, are the absolute best way of hedging your portfolio against downside. I would much rather purchase an ETH Put when I’m feeling like the market is a little bit too high, then sell some of my beloved ETH. To protect against a big ETH drop using options is not very expensive and the payout could easily be 10-20x the initial cost.
Options are honestly, an amazing financial tool. The potential upside and downside on them is huuuuuge. It’s like leveraged trading on steroids with much less risk of liquidation. Sound appealing? That’s why in TradFi, the options market is enormous. It’s also why you have to have a license to do it.
Perps v. Options v. Futures
All of these can be used for very similar strategies. All of these instruments are called derivatives because they are representatives of the underlying assets. Ultimately, they all are essentially betting markets.
Futures are very similar to options except that, with options, you have the option to exercise your contract. With futures, you have to. For the most part, options have taken the place of futures in our use cases.
Options are very similar to futures except, with options, you don’t have to exercise the option. If exercising the option would lose your money, you can just let it expire. There are both Call and Put options.
Perps however don’t have a designated expiration…they’re perpetual, meaning, they don’t expire. The difference is that, with Perps, you have to pay a funding rate. With options, there is no fee for holding them, but you have to predict the correct day.
Why Would I Use Crypto Futures?
For the most part, futures are used with regards to actual, physical resources like corn or oil, because, the whole idea is that you NEED to lock in a sale price in the future and you don’t want to give someone the option to back out. They would also be used by Bitcoin miners. Just imagine you spend all this money upfront mining BTC and then the price of BTC crashes before you mine your first coin. It would be wise for you to lock in some profits before you obtain that asset.
Best used for:
Farming or Bitcoin mining
If you’re spending a lot of money obtaining a resource and you want to lock in profits now, instead of betting on the state of the market when you finally have that resource in-hand.
Why Would I Use Crypto Options?
Read on! But essentially, I would use options if I felt reasonably confident about an asset moving in a specific direction in the near future.
Best used for:
If you are confident on how much a crypto asset will be on a specific date.
Make a lot of money by correctly predicting the market
Why Would I Use Crypto Perps?
I would use a perp if I just wanted to hold a general long or general short position (but I didn’t know exactly when I thought the asset would move), or if I wanted to do leveraged trading. Perps are used primarily by exchanges because they’re much more efficient than trading the actual, underlying asset. There are also strategies using Perps that earn passive yield – see Ethena for an example of that.
Best used for:
Passive portfolio hedging
Leveraged trading
Passive income from funding rate
I could always short crypto with Perps, which just means that I am borrowing the Perp, selling it now, and then paying an interest rate. If I do this with leverage, I could win big, or lose big.
Strategies For Crypto Options
Put Strategies ELI5
Puts are used for shorting and Calls are used for longing – usually.
Let’s say I want to buy a Put for BTC on May 01. I now have to decide how much I want to be willing to sell BTC for on that day (known as the strike price). If I buy a Put for BTC @ $40,000 on May 01, that means I will be entitled to sell BTC for that price on that day.
Obviously, that only benefits me if BTC’s actual price is below $40,000 on that day. With Puts, the higher the price, the more expensive that contract will cost. This is because there’s a counterparty to every trade. If someone is going to sell me a Put for BTC @ $75,000, there’s a really good chance they lose that trade. Thus, they’re going to charge a lot for it.
For example, I can buy a Put option for ETH with a strike price of $4500 on April 26th, but that Put costs about $1181. In contrast, a Put option for ETH with a strike price at $2600 on the same date costs only about $40.
How this works in real time?
I buy an ETH Put with a strike price of $2400 on May 01
ETH’s price is $2000 on May 01
My option is now worth $400 because it represents a contract to sell an asset for $400 more than its market value.
Call Strategies ELI5
Since a Call is an option to buy an asset at a certain price on a certain day, you would always want to buy a Call for below the price I think the asset will be on that specific day.
The pricing for a Call is inverse to the pricing of a Put. With a Call, the lower the predicted price of the asset, the more expensive the option. Why? Because…if I buy a BTC Call option with a strike price for $20,000 on May 01, it’s very likely I win that trade because it’s very unlikely that BTC is under $20,000. The counterparty is very likely to lose that trade so they’re going to sell that option to me for a LOT of money!
How this works in real time?
I buy an ETH Call with a strike price at $2400 on May 01
ETH’s price is $3000 on May 01
My option is now worth $600 because it represents a contract to buy an asset for $600 less than its market value.
Can You Sell Calls & Puts?
This is also known as “shorting” a Call or a Put. And it is possible, but it requires posting collateral because, I only need to payout if I lose the trade, whereas the one buying the Put or Call pays the seller immediately.
Call v. Put TL;DR:
Buy a Put for a price higher than what you think the asset will be on the specific day.
Buy a Call for a price lower than what you think the asset will be on the specific day.
An example:
If ETH drops to $2300, if I have a Put at $2600 or a Call at $2000, the result will be the same. Does that make sense? Take a minute to think through it if it doesn’t.
Put Option $300 above the asset price = Call Option $300 below the asset price
Advanced Crypto Option Strategies
Let’s go a bit more in-depth here. Skip this if you want to keep it simple. We’ll continue exploring different strategies in the future, so subscribe if you want that content.
It’s important to understand that I can both buy & sell a Put or a Call.
If I buy a Put, I am shorting the asset.
If I sell a Put, I am longing the asset.
If I buy a Call, I am longing the asset.
If I sell a Call, I am shorting the asset.
If I buy a Put or I sell a Call, I pay now, and I only get a payout if the asset moves in my favor.
If I sell a Put or I buy a Call, I get paid now, but I have to post collateral which I lose if the asset moves against me. This is basically like selling crypto insurance!
I can combine these strategies to create different exposure strategies. If I hold some calls and some puts in different ratios, I can hedge each position.
I can also mix and match between selling a put or a call, where I get paid upfront, and buying them, where I get paid after. Hell, I could sell a put and then use that money to buy a call if I wanted.
Please please please recognize that these all create different levels of exposure that could get you rekt.
What is the Upside & Downside of Crypto Options?
The downside of buying a Call or a Put is simply how much I spent on the options. The reason is because, if the options expired and the asset is above (or below in the case of a Call) the strike price of my Put, I would simply let the options expire, making them worthless.
The upside of buying a Put is the strike price of the asset. If the asset dropped to zero, I would sell the asset at the agreed upon contract price and pocket all of it. So, for example, if I bought a Put for ETH with a strike price at $2600 on April 26 and along comes April 26 and ETH is 0 (god forbid)…I would sell my ETH and make $2600. Considering that these particular options cost about $40 a pop, that would be a 65x. Anyone who had puts on LUNA before its crash made out like a bandit.
The upside of buying a Call is basically infinite. Technically, there is no limit to how high the asset can go. Imagine, you buy an ETH Call with a strike price at $3000. If ETH goes to $100,000 (please God), you know get to BUY 1 ETH WORTH $100,000 FOR $3,000.
Why Is It Hard To Create a Crypto Options DEX?
When trading crypto, I personally only want to use DEXs. The issue was that, until now, finding a DEX that supports options trading was very hard. This was for two reasons:
Until recently, there wasn’t a great L2 yet and trading options on mainchain ETH was very expensive.
It is very difficult to design a system of smart contracts that can accurately manage a options DEX. There are very few people in the space with this kind of knowledge.
The options basically are: Lyra, Aevo, and Premia. I will be publishing an advanced guide about this in the future.
Just a note – A real benefit of Lyra, is that they’re the first and only DEX that incorporates advanced option strategies when calculating collateral requirements. What I mean by this is, imagine if you combined buying a put and selling a put. You should be required to post collateral for selling a put, but you also have an additional trade that cancels out a part of that collateral requirement. Lyra automatically calculates this and only requires collateral for the specific exposure you have, even if that exposure is affected by multiple different, hedging option positions. For most of us, this isn’t so relevant.
Parting Words
If you want a guide for actually shorting crypto, check out this article.
All in all, I hope that this gives you a solid understanding of options. Feel free to comment below or hit me up on Twitter if you have any specific questions.
As always, none of this is financial advice. I am not telling you to buy or sell anything, just sharing my underlying research and conclusions.
I do hold a portfolio of cryptocurrencies. I was not paid by anyone to write this article. I do not hold Lyra’s token. I do not hold any option positions on Lyra or anywhere else at this moment.
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