Most of the topics we cover here in Know Your Options are about stock options. Most of Zacks’ research is in stocks, so I assume that most of our readers who trade options want to speculate on a stock, protect a position in a stock, or generate income from selling options on a stock .
Recently, however, there has been a lot of interest in trading futures and options on cryptocurrencies like Bitcoin. So I’m going to do a multi-part series on the trading tools and venues available to traders.
I’ll start with a brief introduction to how someone could speculate or hedge with publicly traded commodity options.
Trading futures and futures options can be intimidating, but the basic concepts aren’t really that different from stock options. You just need to familiarize yourself with a few small mechanical differences.
If you have an opinion on the direction of commodity prices, you can find liquid futures and options on the market Globex of the CME Group (CME) Trading platform. In the late 1970s, the CME pioneered the development of futures contracts that were based on a financial instrument as an underlying asset rather than a physical commodity. You can trade futures and options on bonds, interest rates, stock indices, and even the weather.
These product offerings now include futures and options on Bitcoin. They offer a full size bitcoin contract with the base value being 5 bitcoin and a micro contract for 0.1 bitcoin. Both are quoted in relation to the price of a coin. Because of the ability for traders to earn low risk arbitrage profits when prices differ, you will find that the prices for the two contracts are almost always the same.
Options are only available for full-size contracts.
First of all, you need to be able to trade futures on your brokerage account. This process is different for every brokerage house, but almost all popular online brokers now offer futures trading.
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Next, you need to understand the contract specifications. With Bitcoin, each contract is valid for 5 Bitcoin and the prices are given per coin. So if you buy a Bitcoin futures contract for a price of $ 55,000, you now have 5 coins for a face value of $ 275,000. If the price goes up to $ 56,000 / coin and you sell, your profit will be $ 5,000 (minus commissions and fees).
It is important that the orders are large. If the price of Bitcoin moves around $ 1, you will make or lose $ 5. With $ 58,000 and a movement of $ 1,000 or more during almost every trading session, the income statement will pile up quickly!
Note: For commodity options, you generally want to close a futures position before it expires. While there are colorful anecdotes about a dealer failing to close a position and dropping 5,000 bushels of corn on his lawn and it’s a good comedy, it’s not true. Physical delivery takes place at railway hubs or ports. If you accidentally accept a delivery, it will not go to your lawn. However, you pay high fees for reselling the physical product.
In the case of Bitcoin, this is less of a problem. Because final settlement is cash, you can simply let contracts expire and the clearinghouse will credit or debit your account in US dollars.
You can still see extreme price volatility in the expiring contracts when they are about to expire. Therefore, it is still a good idea to close a position or “roll” it to another contract month before it expires.
CME’s options contracts are settled using futures contracts. That is, if you have a call option that expires in the money, you are now long a futures contract at the strike price. In the same example as above, if you bought a call with a $ 55,000 strike.
If the price of a bitcoin was $ 56,000 when the call expired, you would buy a futures contract for $ 55,000 that you could either liquidate for a total profit of $ 5,000 ($ 1,000 per coin times 5 coins) or continue to hold.
Bitcoin options are European-style and can therefore only be exercised / assigned once they have expired.
If you didn’t want the futures contract, you can simply sell the option on the open market before it expires. If it’s in the money, there’s a good chance it will trade very close to its intrinsic value on the last day of trading.
All terms relating to bid / ask spreads, multi-leg spread trading, and the general mechanics of the market are the same as those of stock options. Just like stock options cleared by Options Clearing Corporation, CME Clearing Corp acts as the counterparty for all transactions and guarantees the trades by requiring margin deposits. There is no counterparty risk.
Your main resource will be the CME website. It contains a lot of information on contract specifications and the mechanisms of trading and expiry – especially the date and time.
Trading futures and options on futures doesn’t have to be confusing. If you are aware of the differences between futures as an underlying asset instead of stocks and the different contract specifications, it is no more complicated than trading options on individual stocks.
Just make sure you are familiar with the products you are trading in and then take your position.
Next week, in Know Your Options, we’ll be exploring some of the ways you can take bitcoin price risk using traditional stock options. If you have specific questions about trading crypto options, email me at firstname.lastname@example.org and I will do my best to answer them.
David Borun operates the Zacks Marijuana Innovators Portfolio as well as the Black Box Trading Service and the Short Sell List Trading Service. Would you like to see more articles by this author? Scroll to the top of this article and click the “+ Follow” button to receive an email every time a new article is published.
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