Options. Unlimited Profit, Limited Loss
Options are one of the most complex yet profitable financial instruments.
In this article, we will elaborate on the basic concepts related to options and take a closer look at the nuances of this tool, available on the largest cryptocurrency exchange Binance.
An option is a contract where the buyer acquires a right to buy/sell any asset (product, security, currency, etc.) at a certain point in time at a predetermined price. It is worth noting that this is one of the most complex financial instruments available on exchanges.
The essence of the option is the ability to buy (Call) or sell (Put) the underlying asset at a chosen price. Thus, you are basically buying the opportunity to execute a trade on the asset later at a predetermined price. This price is the option purchase price; it is called a strike. Each option has its own term or expiry date — you can’t postpone a deal forever, right? The end time of the option is called expiration. At that point, you will have to fulfill the conditions of the option.
A few more important concepts:
The price at which one buys an option is called a premium. It represents the price the buyer of the option is willing to pay the seller for the right to purchase the underlying asset in the future. The price is meant to cover the risks of an adverse price change for the seller.
An option buyer is a party that pays a premium to the seller for the right to buy an underlying asset at the strike price at the time of expiration. The maximum profit of the buyer has no limit, while the marginal loss is equal to the size of the premium.
An option seller is a party that bears the risks of adverse price changes, for which he receives a premium from the option buyer. The maximum profit of the seller is equal to the size of the premium, while the marginal loss has no limit.
Difference between put and call options
The call option gives its buyer the right to purchase the underlying asset at a fixed price at a given time. Accordingly, the put option gives the right to sell the asset at a fixed price at a given time.
By purchasing a call option, the buyer expects a future price increase of the underlying asset. In this case, he will be able to exercise his right to “buy” (for example, bitcoin) at a price indicated in the contract (i.e., below the market value) upon expiration of the option. In the case of an “American” style option, you can buy the underlying asset at any time before expiration.
Put options represent an opposite scenario: the buyer expects the price to fall below the contractual price to “sell” the underlying asset (to the derivative seller) in the future.
Since the option is settled in cash, its buyer simply receives profit from the difference between the market and contract prices. In the derivatives market, a call option is similar to a long position in the underlying asset, and a put option is similar to the short one.
Options types depending on the expiration
There are two types of options: American and European. The difference is that American options allow you to demand execution at any point in time, while European options may only be executed on a specific date.
Options trading is currently available on a number of major exchanges, including Binance. Let us consider in more detail what types of options are used on the largest cryptocurrency exchange and what the nuances are.
Binance options are American options, which means that traders can execute the contract at any time prior to expiration. The validity period of Binance options is concise — from 10 minutes to 1 day.
With Binance options, traders can only take the buyers’ side, while Binance acts as the sole issuer (options seller); thus, there is no order book on Binance options. The option contract will remain valid until the holder of the option executes it before or at the expiration date. The maximum loss for each position is equal to the premium paid for the option. The breakeven point may be the strike price plus/minus the premium (depending on the type of the option).
It is essential to know that futures and options wallets are combined on the Binance platform. When calculating options profits, the premium is calculated first (deducted from the balance of the futures wallet), while the profits are calculated after. In some cases, this deduction may lead to the liquidation of the futures positions.
Before placing an option order, you need to make sure that you have a sufficient margin room on the futures wallet. Keep in mind that in order to receive net profit from trading options, profits must exceed the premium. Profits can range from 0 to infinity, while the premium is a fixed amount you pay while opening the trade. Thus, options have a fixed price and a possible unlimited profit. Net profit for options trading is the difference between profit and premium.
All transactions are executed at the market price, and the execution price may slightly differ from the amount that you see on the screen.