Lecture 4.1: Introduction to cryptocurrency call options
Hopefully you’re beginning to internalise how a call option works by now. In this section we will be adding an extra layer to what you’ve learned so far by moving onto cryptocurrency call options.
We will be looking specifically at the cryptocurrency options available on Deribit. For the most part these cryptocurrency call options work exactly the same as the call options we’ve covered so far. The buyer of a bitcoin call option for example is purchasing the right to buy bitcoin, just like the call options we covered in Course 3.
There is one important difference though.
Collateral matters
The cryptocurrency call options on Deribit use the cryptocurrency itself as collateral, not dollars as in the previous section. This means that your account balance will be in bitcoin for example, rather than US dollars. Any profits or losses will also be paid and received in bitcoin.
While this seems on the face of it to be a minor difference, it leads to an interesting difference in the profit/loss calculations of the options when calculated in bitcoin. The payoffs now have a curve to them rather than the previous linear payoffs. Don’t worry if you’re not sure what that means, we will explain how it works in this section, including some live examples.
Using the cryptocurrency itself as collateral, also leads to a difference in the breakeven point and maximum profit/loss calculations. It’s important to be aware of these differences, particularly when making the jump over to cryptocurrency options from options in traditional markets. To competently trade any instrument, you need to be fully aware of how and where you will make a profit, where your risk lies, and the magnitude of each.
These differences we’re going to work through in section 4, are not specific to bitcoin, or even cryptocurrency. They arise simply because we are using the underlying asset itself as the collateral, and any profit/loss is also paid in this same asset. The same formulas would apply if we were using Facebook shares as collateral for trading Facebook options, or Amazon shares as collateral for Amazon options.
Base currency and quote currency
With the cryptocurrency options on Deribit, we are using the base currency for collateral and payments, rather than the quote currency. The profits are still calculated in the quote currency (USD), but they are paid in the base currency (BTC).
You can think of any tradable currency or asset pair as the price of the base currency, quoted as an amount of the quote currency. Or put another way, how many of the quote currency it takes to purchase one of the base currency. In the example shown here, how many dollars it takes to purchase one bitcoin.
In section 4 we will first work through each of the differences that arise due to this, showing you how to make the calculations precisely yourself. We will then move on to some live trade examples so you can see exactly how to place trades on cryptocurrency call options.
Lecture 4.2: Profit/loss calculations for cryptocurrency call options
A call option gives the holder the right to buy something. The same is true for a cryptocurrency call option. When a call option expires, it’s value will be equal to any amount over the strike price that the underlying price is. Again this is true for cryptocurrency call options, so why do we have a separate lecture for calculating the profit/loss of cryptocurrency call options?
The reason is that while the profit or loss is still calculated in dollars, the cryptocurrency options on Deribit use the cryptocurrency itself as collateral. This means that after calculating how many dollars the call option is worth at expiry, this amount must then be converted into the cryptocurrency. The premium paid for the option is also set in cryptocurrency, so when calculating the profit we need to subtract the amount of cryptocurrency paid for the option, from the amount of cryptocurrency received.
For this lecture we will be using bitcoin specifically as the cryptocurrency, but this applies equally to the ethereum contracts, or any other contract that uses the asset itself as collateral.
Calculating profit/loss in bitcoin
Example 1
Suppose bitcoin is currently trading at a price of $11,000. We expect the price to increase so we purchase a bitcoin call option with a strike price of $12,000. The price of this call option is 0.05 BTC, that’s 5 percent of a bitcoin.
At expiry, the price of bitcoin has indeed increased to $15,000, and we would like to calculate what our profit is. Remember the balances and profits are paid in bitcoin, so our end result will be an amount of bitcoin that we have made.
The first step is exactly the same as the steps we took in lecture 3.3, where we calculated the profit/loss of options that used dollars as collateral. We first calculate how much the option is worth in dollars at expiry.
The price of bitcoin at expiry is $15,000, and the strike price is $12,000, so to calculate the value of the option in dollars, we subtract the strike price from the underlying price.
$15,000 – $12,000 = $3,000
The option is therefore worth $3,000 at expiry. So, how much is this in bitcoin? We know the current price of bitcoin is now $15,000, so $3,000 has a value of 0.2 BTC. This is calculated as:
$3,000 / $15,000 = 0.2
This means that when the option expires, we will receive 0.2 BTC into our account.
There is one more step before we know our total profit/loss for the trade. We need to subtract the premium we paid. We initially paid a premium of 0.05 BTC for this option, so our profit/loss can be calculated as:
0.2 – 0.05 = 0.15 BTC
That’s it. Our profit on this call option is 0.15 bitcoin.
General formula
Before we work through some more examples, it’s worth expressing this process as a general formula. As with our calculations from section 3, if the call option expires out of the money, that is, the underlying price is below the strike price at expiry, then the buyer’s loss is equal to the premium paid for the option.
If the underlying price is above the strike price though, then we can calculate the profit or loss in bitcoin using this formula.
And of course, any profit for the buyer is a loss for the seller, and vice versa. So the formulas for the seller’s profit or loss are the negative of the formulas for the buyer’s profit or loss.
Armed with these formulas, let’s tackle a few more calculation examples.
Example 2
Suppose bitcoin is currently trading at a price of $14,500. We expect the price to increase so we purchase a bitcoin call option with a strike price of $15,000. The price of this call option is 0.08 BTC.
At expiry, the price of bitcoin has indeed increased to $20,000, and we would like to calculate what our profit or loss is.
The bitcoin price of $20,000 is above the strike price of $15,000, so the option has some value, and we can use the formula in the top row.
This long call option position therefore made a profit of 0.17 BTC.
Example 3
Suppose bitcoin is currently trading at a price of $14,000. We expect the price to increase so we purchase a bitcoin call option with a strike price of $15,000. The price of this call option is 0.075 BTC.
At expiry, the price of bitcoin has indeed increased to $16,000, and we would like to calculate what our profit or loss is.
The bitcoin price of $16,000 is above the strike price of $15,000, so the option has some value, and we can use the formula in the top row.
This long call option position therefore made a loss of 0.0125 BTC. Notice this time that the price still moved in the desired direction, and the option did have some value at expiry. However, this value was not large enough to make up for the premium paid for the option. This resulted in a small loss.
This highlights why it is not enough for the underlying price to simply move above the strike price. For the call option to make a profit at expiry, price also needs to move far enough to compensate for the premium paid. In other words to the breakeven point, which we will calculate later in Course 4.
Example 4
Suppose bitcoin is currently trading at a price of $14,800. This time, we expect the price to stop increasing so we sell a bitcoin call option with a strike price of $16,000. The premium we collect for this call option is 0.1 BTC.
At expiry, the price of bitcoin has actually increased to $18,000, and we would like to calculate what our profit or loss is.
The bitcoin price of $18,000 is above the strike price of $16,000, so the option has some value, and we can use the formula in the top row. But we are the seller this time, so it’s the seller formula that we use.
This short call position therefore made a loss of 0.0111 BTC.
Example 5
Suppose bitcoin is currently trading at a price of $10,500. We expect the price to stop increasing so we sell a bitcoin call option with a strike price of $11,000. The premium we collect for this call option is 0.09 BTC.
At expiry, the price of bitcoin has decreased slightly to $10,400, and we would like to calculate what our profit or loss is.
The bitcoin price of $10,400 is below the strike price of $11,000, so the option has no value, and we can use the simple formula in the bottom row.
= Premium
= 0.09
This short call position made a profit of 0.09 BTC.
Example 6
Suppose bitcoin is currently trading at a price of $9,000. We expect the price to increase so we purchase a bitcoin call option with a strike price of $10,000. The price of this call option is 0.08 BTC.
At expiry, the price of bitcoin has decreased to $5,000, and we would like to calculate what our profit or loss is.
The bitcoin price of $5,000 is below the strike price of $10,000, so the option has no value, and we can use the formula in the bottom row.
= – Premium
= – 0.08
This long call option position therefore made a loss of 0.08 BTC. It doesn’t matter that the price of bitcoin fell way below our chosen strike price of $10,000. The maximum a long call option position can lose is the premium paid.
This lecture should serve as a useful reference for checking how these calculations are made. You may wish to come back to it when we’re working through more examples later in the course, or when you’re calculating the profit/loss of your own option positions.
While it is useful to know how to do these calculations yourself, once you’re trading live you’re unlikely to want or need to do these calculations by hand every time. Thankfully you don’t have to. A simple spreadsheet or a handy tool like the Deribit position builder will do these calculations for you, and even show you the possible profit/loss at every price point. By plotting these PNL charts rather than manually calculating how much a position would make at various underlying price points, you can see at a glance exactly where your position makes a profit or loss, and how much. This is particularly useful when we come on to multi leg option positions.
Deribit Position Builder: pb.deribit.com
As we mentioned in example 3, it is also useful to know at what underlying price a cryptocurrency call option will breakeven. The next lecture will explain this.
Lecture 4.3: Breakeven points for cryptocurrency call options
Just as with options that use dollars as collateral, it is useful for traders to know where their cryptocurrency options will break even. It’s important to be aware of the difference in how this is calculated for cryptocurrency options to avoid any unwanted profit or loss surprises.
For call options that use dollars as collateral, you may remember that the breakeven point is simply:
And this time it is the premium amount in bitcoin (per contract) that we use in the calculation, not the dollar value.
Breakeven for buyers and sellers
Before we look at some examples, it’s worth mentioning that as with the dollar options, the breakeven point for cryptocurrency options is the same for the buyer and seller.
Example 1
Let’s first use the option from example 1 in the previous lecture. This was a bitcoin call option with a strike price of $12,000, and a premium of 0.05 BTC.
This means if the bitcoin price is $12,631.58 when the option expires, the trade will have broken even, leaving your bitcoin balance the same as it was before the trade.
Example 2
Suppose we purchase a bitcoin call option with a strike price of $11,000, and we pay a premium of 0.11 BTC for it.
This means if the bitcoin price is $12,359.55 when the option expires, the trade will have broken even, leaving your bitcoin balance the same as it was before the trade. As we are long this option, any bitcoin price below this will result in a loss, and any bitcoin price above this will result in a profit.
Example 3
Suppose we sell a bitcoin call option with a strike price of $16,000, and we collect a premium of 0.08 BTC for it.
This means if the bitcoin price is $17,391.30 when the option expires, the trade will have broken even, leaving your bitcoin balance the same as it was before the trade. As we are short this option, any bitcoin price below this will result in a profit, and any bitcoin price above this will result in a loss.
Premium and its effect on the breakeven point
The higher the option premium, the further away from the strike price the breakeven price will be. High option premiums favour the option seller then, as the price needs to move further before the seller will start making a loss. The option buyer on the other hand will of course benefit from lower option premiums, because the price will then need to move a smaller distance before they start to make a profit.
In summary
The breakeven point for cryptocurrency call options is not calculated in the same way as for dollar options. For this reason it’s important not to confuse the two calculation methods.
Remember to use the bitcoin premium of the option, rather than the dollar equivalent. It is also the per contract amount that should be used, regardless of the actual position size.
The larger the premium of the option, the further away from the strike price the breakeven price will be.
Lecture 4.4: Buying vs selling cryptocurrency call options
On Deribit it is possible to both buy and sell any of the cryptocurrency options available, including the bitcoin call options.
Apart from any trading fees, an option contract is a zero sum game. Any profit made by a call option buyer will result in an equal loss made by the call option seller. Conversely any loss made by a call option buyer will result in an equal profit made by the call option seller.
The differences in the PNL calculations that we went through in lecture 4.2 mean the profit/loss chart for both buyer and seller are a little different to the dollar call options discussed in section 3.
Let’s study the option we looked at in example 1 in lectures 4.2 and 4.3. This was a bitcoin call option with a strike price of $12,000 and a premium of 0.05 BTC.
The profit/loss of the call option buyer is shown in blue, and in red we can see the profit/loss of the call option seller. At each level of underlying price, the PNL lines for buyer and seller are an equal distance away from the x-axis, but on opposite sides, one positive and one negative.
Where each line crosses the x-axis represents the breakeven point, i.e. the point at which $0 profit or loss is made. The buyer and seller of the option share the same breakeven point as well (this is ignoring any trading fees). As we calculated in the previous lecture, the breakeven point is $12,631.58.
Fixed profit for the seller
The profit for the seller is still fixed to the premium collected, just as the buyer’s risk is fixed to the premium paid. With the bitcoin options on Deribit this premium is a fixed amount of bitcoin, rather than a fixed amount of dollars.
Risk for the seller
For options that use dollars as collateral, you may remember that:
“When the underlying price increases above the strike price, the potential profit for the call option buyer is unlimited, and the potential loss for the call option seller is also unlimited.”
Both of these statements of course are referring to dollar amounts.
This is where the differences in cryptocurrency call options on Deribit will begin to stand out. The profit of the buyer of a bitcoin call option is actually capped, at 1 bitcoin (minus the premium paid). Similarly the loss of the seller of a bitcoin call option is capped at 1 bitcoin (minus the premium collected).
No matter how high the bitcoin price goes, a single bitcoin call option can be worth at most 1 bitcoin. This is true of course for any asset, because the right to buy an asset cannot logically be worth more than the asset itself. Why would anyone pay for the right to buy an asset, if they could purchase the asset for less than the cost of that right?!
Remember, as we touched on in lecture 4.1, the reason this difference exists with the cryptocurrency call options on Deribit, compared to the dollar options we discussed previously, is because here we are using the asset itself as collateral. I.e. We are using the base currency (bitcoin) as collateral, rather than the quote currency (dollars). If we were instead trading bitcoin options with the quote currency of dollars as collateral, as is the case on the CME for example, then all the same rules and calculations we discussed in section 3 would apply, with none of the differences we’re covering in section 4.
To reiterate, the differences we’re working through in section 4, are not specific to bitcoin. They arise simply because we are using the asset itself as the collateral. The same would apply if we were using Facebook shares as collateral for trading Facebook options, or Amazon shares as collateral for Amazon options. With shares this would of course be impractical, but as bitcoin is a divisible currency, it works just fine.
Getting back to the risk for the seller of the bitcoin call option, they can still lose far more than they collected in premium, but it is capped at 1 bitcoin (minus the premium collected). Even though there is technically a cap on the risk when measured in bitcoin, it is still advisable for new traders to make themselves fully aware of the risks before selling cryptocurrency options. This is even more the case with cryptocurrency put options, which we will cover in section 6.
The effect of time
Time has the same effect on cryptocurrency options as it does on the options discussed in section 3. Time works against the buyer as it puts a time limit on them being correct. For the seller, this works in their favour. Every day that passes, the option will lose a little bit of it’s value. The more time that passes without the underlying price increasing, the more value the call option will lose, and the more profit the call option seller will be making.
Margin
When buying a cryptocurrency option, the buyer is required to pay the entire premium up front to open the position. As the maximum the long call option can lose is the premium paid, this is the only capital the buyer needs to use.
The maximum loss for the seller though can be more than they collect in premium, so they are required to keep an extra amount in their account to cover potential losses. This amount is called their margin, and is calculated according to formulas that you will find on the exchanges website.
In summary
Selling a cryptocurrency call option is the opposite of buying a cryptocurrency call option. Both the risk and reward are reversed. Any profit for the seller is a loss for the buyer, and vice versa.
Buying a bitcoin call option is a bet that the underlying price of bitcoin will increase, and selling a bitcoin call therefore is a bet that the underlying price of bitcoin will not increase. Or at least not increase beyond the strike price.
The seller of a bitcoin call option has a limited profit potential. Their maximum profit is the premium they collected for the call.
As we’re using bitcoin itself as collateral instead of dollars, the seller’s risk does have a cap when measured in bitcoin. However, they can still potentially lose far more than they collected in premium. The seller must also be familiar with the margin requirements for short option positions.
When you’re brand new to options, it’s best to wait until you’re confident you have sufficient knowledge of the risks before selling options.
Lecture 4.5: Maximum profit/loss of cryptocurrency call options
In this lecture we will cover the maximum profit or loss of a bitcoin call option, measured in bitcoin, for both the buyer and the seller. It’s particularly important to be aware of how this differs to the calculations given in lecture 3.7.
Firstly, this table shows how to calculate the profit or loss of a bitcoin call option position for either the buyer or seller. To keep things simple, we’ve left out the position size i.e. the number of contracts. To adjust for that you would just multiply by the number of contracts afterwards.
If you’re mathematically minded, you may be able to see that this section of the formulas:
(BTC Price – Strike Price)/BTC Price
Will tend towards 1 as BTC Price gets larger, given that the strike price never changes. And in turn this will help you see where the maximum profit/loss formulas come from.
Max profit/loss
It’s always useful to know the maximum potential profit or loss of any option position you’re thinking of opening.
Here we can see the bitcoin profit and loss chart for a bitcoin call option. The buyer’s PNL is in blue, and the seller’s PNL is in red. The distance between the lines and the x axis for prices below the strike price, is equal to the premium paid. And the PNL lines for prices above the strike price are calculated using the profit or loss formulas we just looked at.
You could be forgiven for thinking the maximum profit for the buyer, and maximum loss for the seller, is unlimited here, just like with the dollar call options in section 3. However, as we touched on in the previous lecture, this is not the case. Due to the curve in the payoff lines, the maximum profit for the bitcoin call option buyer is capped at 1 bitcoin (minus the premium paid). The bitcoin call option seller’s loss therefore is also capped at 1 bitcoin (minus the premium collected).
This results in these maximum BTC profit/loss formulas:
It’s worth noting again that if measured in dollars, these formulas for maximum profit or loss would be the same as the ones given in lecture 3.7.
It’s because we are measuring things in bitcoin here (the base currency) that they are different.
For the bitcoin call option buyer, their profit continues to increase for every dollar increase in the underlying bitcoin price. Every time the bitcoin price increases by a dollar though, that means that less bitcoin is needed to pay that $1 profit.
This is because as the bitcoin price changes, so does the value of $x when measured in BTC. For example when the bitcoin price is at $10,000, $1,000 is 0.1BTC (1000/10000). However, when the bitcoin price is at $20,000, $1,000 is 0.05BTC (1000/20000).
The result of this ever smaller amount of bitcoin required to pay each subsequent $1 increase in profit, is that the maximum profit for the buyer, and the maximum loss for the seller, is capped at 1 bitcoin (minus the premium).
The call option buyer will suffer their maximum loss when the underlying price at expiry is below the strike price of the call option. When this is the case they lose the premium they paid for the option, but nothing more.
Similarly for the call option seller, they make their maximum profit when the underlying price at expiry is below the strike price of the call option. The seller gets to keep the premium they collected, and does not have to pay anything out. Their maximum profit is equal to the premium collected.
In summary
The buyer of a cryptocurrency call option on Deribit has a fixed risk. Their maximum profit measured in dollars is still unlimited, but when measured in bitcoin is capped at 1 minus the premium paid.
The seller of a cryptocurrency call option on Deribit has a fixed profit. They also have potentially unlimited dollar risk, but measured in bitcoin this risk is capped at 1 minus the premium collected.
While the calculations in dollar terms are the same as section 3, when measured in bitcoin they are quite different. This difference is important to familiarise yourself with if you are used to using dollars as collateral for options on things like stocks or commodities, and are making the move over to cryptocurrency options for the first time.
Lecture 4.6: Trade example – Cryptocurrency call option long (buy)
It’s time for our first live example of a cryptocurrency option trade. There will be many more examples later in the course that focus more on reasons for taking a trade and how the positions behave over time, including the Greeks. However, as many people will be new to crypto options in general, and new to Deribit specifically, we will spend a little extra time covering how to actually use the website in these first 4 Deribit examples (2 in this section, and 2 more in section 6).
In this first example we are going to buy a bitcoin call option live on the Deribit website. We will take a look at the Deribit option chain, locating the option, using the option order form, and placing the trade. We will then look at our potential profit at expiration, taking into account the premium we pay and the strike price, and we will then let the option expire. Once the option has expired we will analyse how the position performed and calculate how much profit/loss was actually made.
Current price
As we’ll be trading bitcoin options today, let’s take a quick look at the current bitcoin price. This is a chart of the bitcoin price on Coinbase, which is a well known exchange where people can buy bitcoin. Coinbase is also one of the constituents of the Deribit index, which is used to settle the Deribit options and futures.
This is a four hour chart, so each candle represents four hours. Although there are vertical lines here to denote ‘sessions’, bitcoin doesn’t have sessions in the same sense as our previous examples on SLV. Bitcoin, and indeed all cryptocurrencies, are running 24 hours a day. Most crypto native trading platforms are also open for business 24 hours a day.
Coinbase for example is open 24/7, and this is also the reason you don’t see any gaps between the bars on this chart. However there are some venues like the CME that offer bitcoin futures that are not open at the weekend. At these venues you can see gaps over the weekend while their market is closed. You can see some examples on this chart of a CME bitcoin futures contract.
Back to the Coinbase chart for now. Today is Thursday the 21st January 2021, and bitcoin is trading at about $31,684 on Coinbase. As you can see the price has dropped quite significantly so far today, but let’s say we have an opinion that this decrease in price is going to be very short lived, and that price will bounce back significantly, similar to what happened back here on the 11th and the 4th. To capitalise on this if it does happen, we’re going to buy a bitcoin call option that expires in 2 days (on Saturday the 23rd January) with a strike price of $33,000.
Back to Deribit
Let’s head back over to the Deribit option chain. You should recognise the layout of this page from lecture 2.6 where we looked at the basic structure of option chains. As a brief recap, we have strike prices in the middle column, with call options to the left, and put options to the right.
As you can see in the top left, I have the 23rd of January option chain expanded, so every option we can currently see expires on Saturday at 0800 UTC. We want the $33,000 strike, which we can find in the middle column. And we want the call so we move left from here.
The current best bid is shown in the bid column in green, and the current best ask is shown in the ask column in red. These prices shown are an amount of bitcoin. For example a price of 0.016 means 0.016 BTC, or 1.6% of a bitcoin.
You may also notice a third price listed in between the bid and ask columns. This is the mark price column which I personally always have shown. The mark price is what Deribit risk management is currently valuing each option at for margining purposes. The mark price is not a tradable price, but can help give you an idea of current option values.
The option order form
In the option chain we can only see the best bid and best ask, but to see all the bids and asks, we can click on the option we want to view. This brings up the option order form for this option, which includes the orderbook of bids and asks on the right. If you’re coming over from traditional exchanges, you may or may not be that familiar with seeing the full order book for every product, but on cryptocurrency exchanges this is the norm.
We can see a list of each bid in green along with how many contracts are available at each price. These are other traders’ limit orders to buy this option, so if we wanted to immediately sell this option we could sell into these orders if we wanted to.
And in red we can see the list of asks along with how many contracts are available at each price. These are other traders’ limit orders to sell this option, so if we wanted to immediately buy this option we could buy into these orders if we wanted to.
On the left hand side, is the order form. This is where we fill in our order details, and then execute our trade. At the top we have the details of the current option that we are looking at.
BTC stands for bitcoin.
23JAN21 is the date this option expires.
33000 is the strike price, and
C stands for call option.
So we know we’re looking at the $33,000 bitcoin call option that expires on 23rd January 2021.
Just under this, some of these details appear again but in dropdown menu form. If we wanted to we can adjust which option we are looking at with these, but we’ll stick with the one we are on for now.
Next is the ‘Amount’ field. This is where we enter the quantity for our order. For example if we wanted to purchase 10 contracts, we would enter a value of 10 here. For this example we’re actually going to use the minimum size possible for the bitcoin options on Deribit, which is 0.1.
What this means is that if the price of bitcoin is above our strike price of $33,000 when the option expires, we will receive profit equivalent to if we had bought 0.1 bitcoin at $33,000. Remember from lecture 3.8 where we purchased a call option on SLV. Our 1 option represented 100 shares of SLV, i.e. the contract multiplier was 100. For the cryptocurrency options on Deribit the contract multiplier is just 1, so there is no similar multiplication needed. 1 bitcoin option represents a notional position of 1 bitcoin, and therefore with a position size of 0.1, we have a notional size of 0.1 bitcoin.
With the quantity selected (0.1 in this case), we can move onto selecting the limit price of our order. This is how much we will pay for the option, and it is the amount per full contract, i.e. per quantity of 1. So because our quantity is 0.1, the total we will pay will be 0.1 multiplied by this price. If we were instead purchasing with a quantity of 5, the total we paid would be this limit price multiplied by 5.
We want our buy order to execute immediately so we will use the price of the current best ask, which is 0.016 BTC.
There are a few other settings available here that allow us to change the behaviour of our order, but because we don’t actually need to use any of these at the moment, and to attempt to avoid information overload with this first example, we will leave these for other examples.
Order confirmation
We have successfully set our quantity of 0.1 and price of 0.016 BTC, so let’s click the BUY button. This will bring up the order confirmation screen, where we can check everything has been entered correctly. Everything is correct here, so I will click the BUY button to create the buy order.
There was an order already in the order book at the price we selected so our order executes immediately, as expected. The pop up in the top right of the screen lets us know the order was filled.
Trade placed
We are now long the $33,000 call option, with a position size of 0.1, and we paid 0.0016 BTC. Remember the price of 0.016 BTC was for 1 full contract. As we only bought with a quantity of 0.1, we only pay 10% of this, which is 0.0016 (plus fees, which we will look at later).
If we look back at the option chain again, I’ve enabled the position column. This shows any positions that are currently open, and we can see our long position of 0.1 in this column here.
Closing early
Before we analyse potential outcomes for this trade and calculate the breakeven point, it’s worth pointing out that despite the options on Deribit being European style, we are perfectly free to close this trade whenever we like. To do this we just need to do the opposite of what we did to open the trade.
I’ve come back into the account here a couple of hours after placing the trade to see how it’s doing. Scrolling down to the positions table we can see it’s in a bit of profit as the price of bitcoin has increased since we purchased the call option.
We are going to hold this until expiry as we said initially, but if we did want to close it, we would bring up the order form for the exact same option. We would then enter the same quantity and our chosen price (in this case 0.02 BTC), and as we are currently long this option, we would instead execute a sell order to close our position. We would do this by clicking the SELL button, checking the details in the confirmation pop up, then clicking SELL again.
We are going to leave this open as I said, but as many new traders mistakenly believe they need to hold these options until they expire, it’s worth pointing out how simple it actually is to close them early. And unlike traditional markets, the options on Deribit trade 24/7 so you can literally do this any time you like.
What could happen
Time to take a look at what could happen at expiry. Let’s remind ourselves of the option parameters we have for this position.
-The underlying asset is bitcoin
-The option type is call
-The expiry date is 23rd January 2021
-The strike price is $33,000
-The option price (or premium) is 0.016 BTC per contract
As this is a real world example we will include the fees in our calculations. The fees for placing our trade were 0.0003 BTC per contract. We will cover where you can check this later.
This extra 0.0003 BTC takes our total cost up to 0.0163 BTC per contract. As we have purchased 0.1 contracts, our total cost is 0.00163 BTC. The per contract amount will help us calculate the breakeven, and the total amount paid will help us calculate the possible profit/loss.
PNL Chart
Given all the parameters we just covered, this is the PNL chart at expiry for this option position.
For any price of bitcoin below our strike price of $33,000, we will make the maximum possible loss. This maximum loss is limited to the premium we paid, plus the fees. We paid a premium of 0.016 BTC per contract, and the fees were 0.0003 BTC per contract. This gives us a total cost per contract of 0.0163 BTC. As the contract multiplier is 1 and we purchased 0.1 contracts, this equates to a total maximum loss of 0.00163 BTC.
If bitcoin is any price above our strike price of $33,000 at expiry, we can calculate our profit/loss using the formula from lecture 4.2:
Except instead of just using the premium paid per contract, we can use our total cost per contract including the fee. We’ve also added on the position size multiplier, which is just the number of contracts (in this case 0.1).
The profit/loss line increasing to the right of our strike price is just this same formula plotted for each underlying price of bitcoin at expiry.
PNL Example
As an example, if the price of bitcoin moves back up to $38,000 at expiry, we can calculate our profit as:
As we paid a total of 0.00163 BTC for the option, this would represent just over a 700% return on our investment (0.01152789/0.00163 = 7.07232806), even though the price of bitcoin would only have increased a little over 15%. Short term, out of the money options like this can return large multiples when they do pay off. The catch of course though is that you need to be very accurate on both the direction and the timing for it to pay off.
Breakeven
In lecture 4.3, we gave the formula for the breakeven point of a cryptocurrency call option as:
As with the profit calculations, instead of using just the premium paid, we will use the total cost including fees, which is 0.0163 BTC per contract. The breakeven point is then calculated as:
= 33000/(1 – 0.0163) = $33,546.81
This is the point at which the profit/loss line crosses the x axis.
What actually happened
Now we’ve had a quick look at what could happen, let’s jump forward and find out what actually did happen. Here we have the same 4 hour price chart of bitcoin we looked at just before placing the trade. Except now of course, it is two days later on Saturday 23rd January 2021, and our option has expired.
We can see the point in time we bought the call option on the 21st. After moving down once more, the price did indeed bounce and begin to move higher. Unfortunately for our $33,000 call option, it did not move quite far or fast enough to get above our strike price.
The options on Deribit expire at 0800 UTC, and settle on a 30 minute TWAP of the index leading into expiry. We can check the delivery price for the 23rd by going to the indexes page, then scrolling down to the delivery price log. As you can see here, options that expired on the 23rd were settled using a bitcoin price of $32,889.75, which is just below our strike price of $33,000.
This means the option has zero value at expiry, resulting in the maximum possible loss for this trade of 0.00163 BTC.
The Transaction Log
As the Deribit platform will be new to many of you, it’s worth taking a quick look at how this appears in the transaction log. If we go to the menu, and click ‘Transaction Log’, we have access to every transaction in the account.
We can see the transaction where we initially purchased the option. The option details can be seen in the instrument column. It was a buy order to open the position. The position size was 0.1, and we can see the total change to our account in the ‘Change’ column which was -0.00163.
In the row above we have the expiry of the option. If the option had some value, this is where we would receive the value of the option back into our balance. As the option had no value at expiry though, nothing was received.
Lecture 4.7: Trade example – Cryptocurrency call option short (sell)
In this second cryptocurrency option example, we’re going to sell a bitcoin call option. Unlike the previous example where we let the position expire, with today’s example we are not going to let this option expire. We will initially sell the call, let some time pass, then close the position ourselves before expiry by buying it back.
Hopefully we will manage to buy it back for a lower price than we sell it for to lock in a profit, however we will close it whether it’s currently in profit or not. We’ll be doing this to show how simple it is to close option positions early on Deribit, despite the fact that they are European options. It’s such a common misconception among beginners that they can’t be closed early, that it’s worth making sure this point is understood early, and we’ll do that by giving a specific live example of how it can be done.
Current price
As we’ll be trading bitcoin options today, let’s take a quick look at the current bitcoin price. This is a chart of the bitcoin price on Coinbase, which as we mentioned in the previous lecture, is one of the constituents of the Deribit index, which is used to settle the Deribit options and futures.
This is a four hour chart, so each candle represents four hours. Today is Tuesday the 26th January 2021, and bitcoin is trading at about $32,211 on coinbase. Bitcoin has been chopping around for a few days between roughly 30,000 and 35,000. Let’s say we have an opinion that bitcoin isn’t going to do much in the next couple of days. More specifically, we don’t think it’s going to break above $35,000. To capitalise on this view if we are correct, we’re going to sell a bitcoin call option with a strike price of $35,000, that expires in 3 days (on Friday the 29rd January).
Remember though that we’re not going to wait 3 days until the option expires on Friday. Once we’ve sold the option, we will only wait until tomorrow, then we will come back to see how the position is looking and close it.
Back to Deribit
Let’s head back over to the Deribit option chain. As you can see in the top left, I have the 29th of January option chain expanded, so every option we can currently see expires on Friday at 0800 UTC. We want the $35,000 strike, which we can find in the middle column. And we want the call so we move left from here.
The current best bid is shown in the bid column in green, and the current best ask is shown in the ask column in red. These prices are an amount of bitcoin. For example a price of 0.006 means 0.006 BTC, or 0.6% of a bitcoin.
As in the previous example, the mark price column is shown in between the bid and ask columns. The mark price is not a tradable price, but can help give you an idea of current option values. This time I have also enabled dollar prices for the bid and ask columns. This gives the dollar equivalent of the premium of the option (as calculated using the futures price). Although it is possible to see this dollar price, the premium is always actually paid or received in bitcoin.
The option order form
We can click the $35,000 call in the option chain, which brings up the option order form for this option. This includes the orderbook of bids and asks on the right, which is the list of other trader’s orders that we can execute against if we choose to.
As we want to sell this $35,000 call option, it is the current bids that we are interested in. The current best bid for this option is an order to buy 1 contract for a price of 0.0065 BTC. For today’s example we will sell into this order with a quantity also of 1, meaning we will be short this call option with a notional size of 1 bitcoin.
Once we’ve entered the ‘Amount’ of 1, and checked the price is correct, we can click the SELL button. This will bring up the order confirmation screen, where we can check everything has been entered correctly. Everything is correct here, so I will click the SELL button to create the sell order.
There was a buy order already in the order book at the price we selected so our order executes immediately, as expected. The pop up in the top right of the screen lets us know the order was filled. And we can also scroll down to the positions table to see our short call sitting in the account.
The instrument is listed in the left column. Here it’s BTC-29JAN21-35000-C, which means the currency is bitcoin, the expiry date is the 29th January 2021, the strike price is $35,000, and the option type is call. Next to this we have the size, which is minus one. The reason this is a negative number is because we are short this option. If we had instead purchased the option, it would be a positive number here.
What could happen
Even though we’re going to close this option early, let’s take a quick look at the PNL chart for this option if we were to hold until expiry.
We have all the option parameters I just mentioned:
-The underlying asset is bitcoin
-The option type is call
-The expiry date is 29th January 2021
-The strike price is $35,000
-The option price (or premium) is 0.0065 BTC per contract
The fee was also 0.0003 BTC so we will use 0.0062 BTC as the total collected.
PNL Chart
Given all the parameters we just covered, this is the PNL chart at expiry for this option position.
For any price of bitcoin below our strike price of $35,000, we would make the maximum possible profit. This maximum profit is limited to the premium we collected, minus the fees. We collected a premium of 0.0065 BTC per contract, and the fees were 0.0003 BTC per contract. This gives us a total credit per contract of 0.0062 BTC. As the contract multiplier is 1 and we sold 1 contract, this is a total maximum profit of 0.0062 BTC.
If bitcoin was any price above our strike price of $35,000 at expiry, we could calculate our profit/loss using the formula from lecture 4.2:
Except instead of just using the premium collected per contract, we can use our total credit per contract including the fee. We’ve also added on the position size multiplier, which is just the number of contracts (and in this case is simply 1).
The profit/loss line decreasing to the right of our strike price is just this same formula plotted for each underlying price of bitcoin at expiry.
PNL Example
As an example, if the price of bitcoin moved back up to $37,000 at expiry, we could calculate our profit as:
=(0.0062 – ((37000 – 35000)/37000))*1
= -0.04785405 BTC
Notice how this loss is far larger than the credit we collected. As we covered in lecture 4.5, the maximum loss of a short call option is capped when measured in bitcoin, however it is still possible to lose far more than was collected in premium. This is especially important to remember if you plan to sell more call options than the amount of bitcoin you own.
Selling call options against the bitcoin you do own is called a covered call, which is a popular strategy that will be covered in detail later in the course.
Breakeven
In lecture 4.3, we gave the formula for the breakeven point of a cryptocurrency call option as:
As with the profit calculations, instead of using just the premium paid, we will use the total credit including fees, which is 0.0062 BTC per contract. The breakeven point is then calculated as:
= 35000/(1 – 0.0062) = $35,218.35
This is the point at which the profit/loss line crosses the x axis.
What actually happened
So that’s what could happen if we allowed the option to expire. However, we don’t want to hold this one to expiry, we want to close this option early instead.
Here we have the same 4 hour price chart of bitcoin we looked at just before placing the trade. Except now of course, it’s a day later on 27th January 2021.
We can see the point in time when we sold the option yesterday. Since then the price has decreased steadily. As we are short a call, this is good for our position. Let’s jump back over to Deribit to see how good, and to close the option position.
Closing the trade
Our short option position can be seen here in the option chain. And if we scroll down we can also see it in the positions table.
We are currently short this option with a quantity of 1. To close this early, we just need to buy back the exact same option also with a quantity of 1. So we will be executing a buy order for the amount of 1.
We can bring up the order form for this option by clicking on it in the option chain. Due to the decrease in the bitcoin price, and the passage of some time, this call option’s value has dropped quite significantly.
We want to buy this option back so it is the asks that we are concerned with. The best ask is currently for a price of 0.001 BTC. As we initially sold the option for 0.0065 BTC (minus fees), this will represent a nice little profit for us, so lets buy the option back for this price.
To do this we just enter our amount of 1, and our price of 0.001 BTC, then click the BUY button. This brings up the order confirmation screen for us to check. Everything looks good so let’s click the BUY button.
There was a sell order already in the order book at the price we selected so our order executes immediately, as expected, and we get the pop up in the top right showing the execution. If we scroll down to the positions table we can see that the option has been closed and we no longer have any positions open in this account. What happens between now and expiry is no longer relevant to us, as we have completely closed the option position.
The Transaction Log
If we go to the menu, and click ‘Transaction Log’, we have access to every transaction in the account.
We can see the transaction where we initially sold the option here. The option details can be seen in the instrument column. It was a sell order to open the position. The amount was 1, but as this is a short, the position size was negative 1, and we can see the total change to our account in the ‘Change’ column which was 0.0062 BTC including the fee. As this is a positive amount in green, this means our cash balance was increased by this amount, because we are paid a premium for selling the option.
In the row above is the transaction where we close this position by buying the option back. The same option details can be seen in the instrument column. It was a buy order to close the position. The amount was 1, but this time it reduces our position to zero. And again in the ‘Change’ column we can see the change to our balance. This time we paid 0.001 BTC to buy the option back. With the fee included this totals a 0.001125 BTC reduction to our cash balance.
So our opening sell transaction generated a 0.0062 BTC credit, and our closing buy transaction generated a debit of 0.001125 BTC. This means the trade made a profit of:
0.0062 – 0.001125 = 0.005075 BTC
That’s it, this trade is complete. What happens to the value of this option at expiry has no effect on our account.
Outro
Hopefully these first two cryptocurrency examples have helped you see how the topics discussed in section 4 apply in the real world. They should also have helped highlight that despite some differences with the collateral and the resulting calculations, the process of trading cryptocurrency options has many similarities with trading more traditional options that use dollars (or some other fiat currency) as collateral. So despite the little bit of extra knowledge required, making the jump over from traditional options doesn’t have to be difficult.
Deribit also has a test website (test.deribit.com) where you can try out all of their products in a test environment without risking any of your funds. It is highly recommended to get up to speed on the testnet and then progress to the live site once you’re comfortable with how things work.
The next and last part of this section is a quiz to test how much you’ve remembered so far, but feel free to search back if you need to refresh your knowledge. After that we will move onto put options.
Remember: Options trading involves risk. Never invest more than you can afford to lose. This educational content does not constitute financial advice. Always practice with paper trading before using real capital.
