What are cryptocurrency options? How does their expiration affect the Bitcoin rate?

Interest in cryptocurrency derivatives has exceeded October 2021, when prices on the crypto market reached historical highs. We tell you how options trading works for leading crypto assets

On Friday, November 24, at 11:00 Moscow time, one of the largest expirations of cryptocurrency options will take place on the Deribit exchange worth more than $6.5 billion. A large expiration can cause short-term volatility, has a psychological effect for some traders, and also indicates market maturity.

In a commentary to Bloomberg, Deribit representatives noted that by the end of November, open interest in derivative instruments on the platform reached $14.9 billion, which is $500 million higher than in October 2021, when prices on the crypto market reached historical highs. According to analysts of the publication, the increased interest in various types of investment instruments for Bitcoin is caused by the expectations of market participants regarding the imminent approval of exchange-traded funds (ETFs) by the US Securities and Exchange Commission (SEC).. Investors are expecting an influx of new capital, for which the cryptocurrency market was previously inaccessible.

In traditional trading, open interest (OI) refers to the total number of buy orders available at the time the market opens.. In futures and options trading, open interest is the total number of outstanding contracts at a given point in time.

What is open interest. How to use the indicator in Bitcoin trading

Expiration on November 24 will occur for monthly options (with a life period of 1 to 3 months), although traditionally the most traded options on the market are quarterly options, for which the nearest expiration will occur on December 29. Quarterly options allow traders to more accurately focus on long-term forecasts, where the impact of random events will be less reflected in the price of a derivative than for short-term products.

Forward options, unlike forward futures, in addition to the expiration date, also have an option type (put or call) and a “strike” price.. Buying an option is essentially insurance against an event. Buying a put option protects an asset from a price drop (or protects a long futures position), and buying a call option helps you not get emotional if the price rises (protects a short position).

The expiration date is the date the option expires. The contract is concluded for a certain period of time. For example, for a week, month or quarter.

A call option gives the buyer the right to purchase an asset at a fixed price on or before a predetermined date, and creates an obligation for the seller to sell it when requested.. By buying such an option, a trader or investor takes a long position – long. It is opened in the hope of making money on an increase in the price of an asset.. Accordingly, in order for the buyer to be able to exercise the right to purchase an asset under a call option and make a profit, the price of the asset must be higher than the strike price level.

The strike price, or strike price , is the price at which an investor can buy or sell the underlying asset.. It is spelled out in the contract and fixed on the date of conclusion of the contract.

A put option gives the buyer the right to sell an asset at a fixed price on or before a specified date.. The seller must accept the underlying asset delivered if the buyer chooses to exercise the option.. By purchasing such an option, a trader or investor takes a short position – short, that is, he bets on the fall of an asset and wants to make money on it.

For example, a trader bought put options on an asset with a strike price of $200. Its price dropped to $120, and a trader bought it on the exchange. He decided to demand that the option be exercised, and then the seller would be obliged to buy the asset from the trader for $200, although it was already much cheaper on the exchange. As a result, the trader will earn $80.

In addition to opening a long position (buy or “long”), you can also open a short position (sell or “short”) using options.. This point is often difficult for novice traders to understand, since on the Deribit exchange users trade only among themselves – retail and institutional traders are in one common pool. Any client of the exchange, having the minimum required deposit, can open both a long and a short position.

For most private brokers that were widely represented on the market in the past, trading took place not between clients, but according to the “client versus broker” scheme, and it was impossible to open “short” positions on options.

Open Interest

Indicators of open interest, the ratio of put and call options and other metrics for cryptocurrency options can be viewed on the Deribit exchange website – for Bitcoin (BTC) and for Ethereum (ETH).

Distribution of options for BTC with expiration on November 24 by type (green – call, purple – put) and strikes. Source metrics.deribit.com

The chart marks the points of the so-called Max Pain ( eng. “maximum pain”) – the price at which the maximum number of all options (both puts and calls) expires “out-of-the-money” (OTM), then there are all open options positions will lose value. In this scenario, the seller makes money on the transaction. For Bitcoin (BTC) it is at $33,000, and for Ethereum (ETH) it is at $1,700.

So-called European options cannot be exercised before expiration, but you can close the position if you “sell the purchased” or “buy the sold” option. Thus, it is not necessary to hold a profitable or losing position until expiration – you can make money (or limit losses) at the right time. However, there is still a significant number of active positions before expiration.

This is due to the fact that options have ceased to be a purely speculative instrument, and are increasingly one of the components of complex trading positions that combine different expiration dates, asset types, options types and futures, among others.. For example, a large long position on a call option at a price of $100 thousand. for Bitcoin can be used not only if Bitcoin actually trades at $100 thousand. – it can also be insurance or part of a larger transaction, including futures or spot transactions.

How does expiration affect the market?

The most important aspect of expiration is its size. Growing trading volume is a sign of market maturity. The fact that trading volume (and expirations) is growing year after year suggests that more and more traders are entering the market and in particular derivatives such as European options.

The impact of metrics can also have a psychological effect. Deribit is not the only crypto options exchange, and activity on other exchanges, even if they are smaller in size, also affects the trading community. Not all exchanges allow short options positions, which, together with historical information about traditional brokers, can influence traders' decisions. This sometimes gives rise to theories about manipulation by market makers and trading platforms.

Also, an increase in open interest over time can serve as an indirect sign of traders’ long-term strategy, and the transfer of a position from one major expiration to another. In this case, expiration will be associated with the closing of old positions and the recruitment of new ones, which will affect volatility due to a large volume of sales and purchases. Traders with significant capital try to stretch out this process for several hours and sometimes days. However, it will be difficult to completely neutralize the effect of their actions on the market.