The simplest bitcoin option contracts (BTC) involve the purchase of a call, which gives the holder the option to buy the asset at a fixed price on a specific date. For this privilege, the buyer simply pays an initial amount to the seller of the contract, which is called a premium.

While this is a great way to gain leverage while avoiding the liquidation risk associated with futures trading, it does come at a price. The option premium will increase when markets are volatile, resulting in a transaction that requires even more price appreciation to make a decent profit. The premium is therefore a parameter that investors should monitor closely.

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

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

Bitcoin’s daily volatility is currently 5.4%, which is much higher than the S&P 500 (1.7%). This creates opportunities for arbitrageurs to hold bitcoin and sell a call option to get that premium.

Let’s look at a hypothetical transaction and see what role the premium plays in this scenario.

The probabilities of this transaction are calculated using the Black & Scholes model, and on the Deribit exchange this information is presented as a delta. In short, these are the percentages for each move.

Price of 26. March BTC call option. Source: Deribit.com.

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

According to the chart above, the $54,000 strike for the 26th. March has a 48% chance, according to the option valuation model, which seems reasonable. In contrast, a $58,000 call option has an implied probability of 37%.

With about 20 days to go until the March 2021 expiration date, it seems likely that bitcoin will end the month above $60,000, given today’s price action. If you consider that this call option for BTC is trading at 0.0548, it was worth $2,790 when bitcoin was trading at $50,900.

For this call option to be profitable, the price of CTA must be $60,800. If this buyer had chosen a conservative futures position with 3x leverage, the bitcoin price of $60,800 would have yielded a profit of $1,485.

The options markets are a great way to add leverage, but investors should take the time to carefully analyze the returns before buying rising calls.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Cointelegraph. Every investment and every stage of trading involves risk. You should do your own research before making a decision.

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