All you need to know about BTC options without the fear!

Bitcoin options used to be mainly for the big players and were found on a few specific platforms like Deribit. But now, with Bakkt and CME, the top traditional exchanges, getting ready to offer these products to their clients, options trading in bitcoin is about to get way more accessible. Actually, Bakkt has had options trading available since December 9th, and CME is set to launch a similar service later this month, kicking off trades from January 13th. Options trading can be pretty tricky. This is true in the regular markets, but even more so in a volatile market like bitcoin. In this thread, I'm aiming to share some theoretical and practical tips on how to get your head around options, how to price them, and how to use them. I'll kick things off by explaining what an option is all about, covering its features and why they matter for investors. Then, I’ll give a quick rundown on how to price them. I won’t dive into the heavy math behind the pricing models because, honestly, no one wants to hear advanced calculus. Instead, I’ll explain the factors that affect option prices and how to interpret them. I’ll also tackle some common myths about options to clear things up a bit. Finally, I’ll go over some common trading strategies for options. Nothing too fancy, just a few examples of how to use them based on your investment goals, whether that's for speculation or hedging.

A nice tool to monitor the options market is the dashboard provided by skew.com: Bitcoin Options Dashboard by Skew I will try to explain how to interpret the various graphs. BTCUSD Spot Nothing to see here, a simple graph on a linear scale. Pretty Standard, just to orient ourself checking the other graphs. BTCUSD Realised Volatility We already saw this graph in the OP: this is the historical bitcoin volatility, computed using different time horison. We already noticed the realised volatility observed over longer periods tends to be more stable. BTC Options Volumes In this graphs we see the trading volumes of all options on the different exchanges. We see the vast majority of options has traded on Deribit. I think this is going to change with the launch of the two biggest exchanges BAKKT and CME. Bakkt has actually already launched, but it is barely noticeable. We already noticed Bakkt is a slow starter, but when he got his product rolling, they were slowly grinding volumes. BTC ATM IV This graphs is similar to the historical volatility one, but instead focus on the Implied Volatility. They compute the implied volatility of an at-the-money option (strike price euqalt to forward price of bitcoin) expiring at various tenors: 1m, 3m and 6 months in the future. So this represent the future expected volatility of bitcoin over such horizons. We notice that implied volatility is moving more for shorter term options, and its more stable for longer tenor options. BTC 25d Skew This charts start giving out very technical infromations. This measures the difference in implied volatility terms between two options maturing on the same date. The lines measure the difference in implied volatilites between an out of the money call and an out of the money puts. Both options are chosen with a strike having 25% delta (hence the 25d in the chart title). So the strikes are not fixed in dollar terms, but in "moneyness" or "distance" from the current market levels, so the measure is consinstent over the various market phases. A positive number means call Implied volatility is higher than the put volatility, this means volatility is expected to rise in an upward movement (probably more people wants to buy upside options because want to leverage the price of bitcoin. BTC ATM Volatility Structure This is the level of implied volatility of the options expiring at the various dates expressed below. This gives a similar information as the BTC ATM IV graphs (and informations are actually consistent), losing the historical part , but giving more informations on the expiries, axpressed as fixed dates r(probably expiries dates at the various exchanfges) rathr than "rolling dates (1m, 3m and 6m). Probability of BTC being above x$ per Maturity This is a tricky one. I don't knwo the details of the calculation of this graph, but I think it is greately misleading. The shape of the graphs looks very like the delta of an option with a given strike. Delta of an option can be tought as the risk-neutral probability of an option of being in the money. Well, the kew is that one: risk neutral probability are very different from real world probability. So, O dosmiss this graph as "manure". Please don't draw conclusion from that particular piece of information. BTCUSD - Implied Volatility vs Realised Volatility, Daily This is a very intresting graphs. It combines the realised volatility with the implied volatility over the same horizon: so this graph answers the following quiestiins: "Which level of volatility are markets pricing in, compared to the one they observed in the past?". The graph plots the volatilites over a 3m horison: currently the Implied volatility is pricing above the realised: market are currently expecting volatility to go up on the next months (probably due to the halving event in 5 months). Deribit BTC Options Volumes Pretty straightforard graph. This is the volume of traded options today on deribit. Please not that this is the notional of the options, not the sum of the premium paid. Deribit BTC Options Flows This graph details if the sign of the flow, buy or sell, and the type of option call or put. Of course for every trade there is a buyer and a seller, but when a trade happens on the ask side of the price it's conventionally clasified as a "buy", while when a trade happens on the bid side ofthe market it's called a "sell". We see that the majority of trades are on the call side (this is actually intresting) without much imbalance between buy and sell, so a nice, liquid two ways market. Trade >50 BTC Option Monitor This graph is actually a blotter of the trades that happened on the exchange. Most relevant trades are highlighted. Can give a sense of how the big swinging dicks are trading, but it is always very difficult to extract meaningful information from those blotter without having a complete view of the position under management (i.e. buying 500 BTC put as leverage trading, is vert different buying 500 BTC put becasue you are also long 1000 BTC and you want to protect from the downside). Deribit BTC Option Call/Put Ratio Put Call Ratio is the ratio of the trades on Calls versus the trades on the Put. Again, it's a graph very common amonsgt traders, but with limited or very diffciult information value, in my humble opinion.

Deribit BTC Options Buy/sell Ratio This graphs details if the trades happened on the buy side (asks lifted) or on the sell side (bids given). Again, it's difficult to understand the final positioning looking only at this kind of graph, but a shift in the current state of ratio can signal a shift in general sentiment. Of course, buys and sells should add to 100%. This is not the case in this graph I have no idea why, sometime the sum is below 100% or sometime is even bigger than 100% (on both case there's a white space above to get to 100%). Deribit BTC Options Short-term/Long-term Ratio This graphs again splits the total trades between short term options and long term options. There's no hint on what they mean by short term, but the fact that short term options are more actively traded could potentially mean the trading aspect of those instrument, as opposed to hedging purpouse, has more appeal to traders. Total BTC Options Open Interest AS i detailed on my thread on future ( Everything you wanted to know about BTC futures but were afraid to ask!) Open Interest is a concept often confused with volume. In reality open interest specify the amount of "Open Positions" on the exchange, or the sum of positions that will ultimately could potentially lead to a future settlement. From here we see again that Deribit is by far the most important exchange, with LedgerX and Bakkt Barely noticeable. Again, I do expect this to change in the near future. BTC Options Open Interest by Strike (kBTC) This graph breaks down the Open Interest by the various strikes each position is written on. Looking at this chart we have a glimpse of the strike levels where lies the more interest of the markets. Also, near expiries, large open interest position could act as "magnets" or "barriers" to BTC price, because the hedging positions of option market participants (even thou the total option volume should be a few times bigger to impact hte more liquid spot BTC market). BTC Options Open Interest by Expiry(kBTC) Same as of above, this time the Open Interest is split by the various expiries. Looking at this chart we have a glimpse of the maturity where lies the more interest of the markets. BTC Jan20 Vol As we have seen in the OP the volatility level is not constant for each strike. Here this graph tries to model an implied volatility skew out of the quoted prices. On the call side (the blue lines) we see the prices being consistently narrow, while on the puts the spread is narrow where the options are in the money, while it widens considerably for in the money puts. As the most actively traded options, i.e. the ones we can expect to have more reliable prices, are the out-of-the-money options, these options are the one we consider to fit a volatility smile: so on the right hand of the graph we use the call implied volatilities, while on the left part of the picture we use the puts implied volatilities. As you can see the sum of the two curves, represented by the black dotted line, is quite well shaped. Back Months Vol Vol These graphs are conceptually identical to the previous one, but they are actually reporting the implied volatilities on back months, or longer expiries. As traded volumes and liquidity here is lesser, the graphs are not really well shaped: basically there are no reasonable offers for many puts, so the Y-axis explodes causing the graph to be actually unreadable.

This is really cool and I have to admit that this is one of the greatest things that has happened in the cryptocurrency community, though I have seen some news that relates to Bakkt that once made me lose interest in them, but as time goes on we will get to know the truth. Option trading is really good and this is not the first time that I have been part of it, I have always made use of Robinhood platform which was a really good choice since it’s a free and no commission platform. There are also other good platforms that I have known, I stopped option trading a long time , but I’m looking back into it.

Looks like a great summary of options, OP, though I didn't read the entire thing.  I never traded options in the stock market and don't have any interest in doing so with bitcoin, so I pretty much know all I'm ever going to need to know about them--and options/futures/derivatives never interested me all that much.  I'm of the Warren Buffett school of thought, whereby it's better to own a stock or bond or whatever rather than a derivative of the same. But I'm sure there are people here who don't really know what options are all about, and it's good that you created this nice summary.  It definitely gives you an idea of what goes on at places like Bakkt and the CME.

Great stuff, fillippone. I've been trading for nearly a decade and I've always avoided options due to the complexity underlying their market pricing. It'll take a while for this to sink in but I really appreciate the breakdown.

TL:DR, but I love this statement. People should not doing option trading because it is more complicated, much harder and more risky than spot trading. It would be good to make this as a 'warning' cause we don't want people to lose their money at any trading. If anyone wants to try this, they must be ready for everything that could happen during the journey.

Wow, I really admire your understanding. I confess I am a young person and I often learn about the indicators to make money and rarely learn about the volumes of Bitcoin or the options. Now, after reading the entire article, I realized that this is a way for us to look at the whole picture of the market and look further. Thank you for taking the time to create this article so that everyone can understand more about Bitcoin.

Well, it really is a useful knowledge. Now I understand why you have a huge amount of merit after 1 year of activity on this forum. I admire your understanding, I have just learned about the trading options recently, some of the options you have given here are completely new with me. Thanks for your great contribution, not only me but others also need topic like this from you. We have a big picture here to admire and learn.

Thanks you guys for the appreciation! Yes, it was a long thread to read, but rest assured it was even longer to write! As I had to try to figure out the most important things to describe and explain, please let me know via comment which aspect you want me to dig a little bit more!

I was always recommended to stay away from options by traders who are farther in every facet than I am, which I respected but I kept wondering what made options so complicated and risky to trade. This puts things into perspective and I thank you for that. It kinda makes me happy that I didn't proceed to mess with options despite their utility (utility only for those who understand their workings). I'll just stay within the areas of trading I'm comfortable with. No point in taking on more risk and complicating the whole process of trading. Simplicity is worth a ton. Bakkt should provide a similar explanation since their aim is to be a retail platform, but I'm pretty sure that they won't go that far because it may scare off a lot of people.

Hello, CME made available the full specification of their BTC options. Of course we are talking about cash settled options here. Options on Bitcoin Futures

Option trading is really cool and there was a time I used to think that it was the same thing with stock trading and after a bit of research I got to understand that there’s a difference between the both of them. Option traders benefit from variety of stock market outcomes as you have explained here. I haven’t taken the time to dig into this option trading and understands how it really works, but I’m going to do that soon, and thanks for taking your time write down all these, it’s not easy, not everyone can take out time to break it down like this.

Not always trading can give solution for getting profit because many beginner not understand about how to start trading with bitcoin and altcoin, they look just allowing what other said about which one have to buy and trade, they not really understand about way how to begin with trading and choose best coin can give much profit with their way in trading.

Miners have always found these instruments useful for hedging their investment, and Bitmain caught on to it recently https://coincodex.com/article/6270/bitmain-will-offer-put-options-on-bitcoin-to-mining-hardware-buyers-as-defense-against-price-decline/ Perhaps you could explain how it all helps the miner?

This is very interesting example, and one of the classic use case (wondering why I didn't add it to the OP). Basically a miner is exposed to Bitcoin price fluctuation. They have to pay huge costs in fiat (hardware cost is still anchored in USD -even if paid in BTC-, other costs are mainly paid in fiat (electricity, other costs, workforce etc). Their income is instead denominated in bitcoin. Miners are then forced to sell a certain amount of their BTC income to cover their fiat expenses. In case bitcoin goes up, they will be able to sell bitcoin higher for higher profit. In the opposite scenario they have to sell bitcoin lower to cover they cost, thus reducing their margins. Basically, they are LONG BITCOIN: their profits move with bitcoin price. Graphically the situation is the following. Today the price of bitcoin is USD 8,000. If BTCUSD goes to 10,000 they can sell this bitcoin for a USD 2,000 profit, compared to today. If BTCUSD goes to 5,000 they can sell this bitcoin for a USD 3,000 loss, compared to today. Basically their profit analysis is something like that: At 8,000 they are at breakeven, they lose below USD 8,000 and they gain above. They are totally exposed to BTC price fluctuation, they get the swings on both sides. if a price goes up there is no problem, the miner can pay his bill, and enjoy the profit. If the price goes down, there are serious problems: not only the miner is forced to sell at loss to cover his expenses, but he will be forced to sell more BTC to cover the same amount of USD costs, forcing him into an a death spiral. The solution is buying an insurance, or buying a put. The miner pays a premium in every state of the world to cover himself from a negative outcome (BTC USD Price going down). The negative outcome is avoided with a payoff when the BTC USD goes below a certain level. This payoff is the put option we saw earlier: Put=max(0, Strike- BTC) In the example in the article, Bitmain embedded a MARCH 5000 put in the package (Bitmain sells the put to the miner, who buys it). In the OP I reported the JUN prices, so imagine the same structure , but on JUN expiry. The offer for a 5,000 PUT on JUN is 400 USD (399,97 for the nitpickers, let's round it). What happens at various levels of BTC price: Let's do some calculations. I prepared a sspreasheet with some levels: At 3,000 BTCUSD being long the BTC would imply a loss of 5,000 USD. Having bough a PUT option would have implied an additional cost of 400 USD, and a positive payoff of 2000=max(0, 5,000-3,000), for a total of a-5,000-400+2,000= -3,400 At 5,000 BTCUSD being long the BTC would imply a loss of 3,000 USD. Having bough a PUT option would have implied an additional cost of 400 USD, and zero payoff as max(0, 5,000-5,000), for a total of a-3,000-400+0= -5,400 At 8,000 BTCUSD being long the BTC would imply a breakeven. Having bough a PUT option would have implied an additional cost of 400 USD, and a zero payoff as 0=max(0, 5,000-8,000), for a total of 0-400+0= -400 At 8,400 BTCUSD being long the BTC would imply a gain of 400 USD. Having bough a PUT option would have implied an additional cost of 400 USD, and a zero payoff as 0=max(0, 5,000-8,400), for a total of 400-400+0= 0 At 10,000 BTCUSD being long the BTC would imply a gain of 2,000 USD. Having bough a PUT option would have implied an additional cost of 400 USD, and a positive payoff of 2000=max(0, 5,000- 8,400), for a total of 2,000-400+0= 1,600 Summing up, the payoff would have been: AS you can see , the miner , the buyer of the put options gives up a little bit of gain upside, to buy a protection in case of a lower catastrophic BTC price event. This is the typical example of an option bought for hedging purpose. Please note as the total payoff has a lower risk for the miner: the miner has decreased his risk using this derivatives: this is quite opposite of the mainstream version of derivatives as dangerous instruments.

Dude this is amazinnnngggg!! Its a very good,elaborated and a very neat explanation of options. I didn't read through all the practical thingies you wrote, cause it will fuck with my brain, and thanks for the heads-up cause I am never gonna trade options cause it is definitely not something I would want to risk my money into. But the concept in general isn't quite so bad. You did a phenomenal job in explaining the meaning of what options are, and how they work. Its not everyday where you see proper threads with proper explanations here on bitcointalk. I am still a little confused about the whole thing, I like understood it for a minute, and went like, wait hold on a minute, "How, what, HUH?" and its full Chinese noodles in my head :/ I am gonna read the whole thread again, for a hopeful better understanding. Seems interesting, not gonna lie.

Gentle reminder: today CME is starting to trade option: CME’s Bitcoin Options Launch Today, Here’s What To Expect Indeed Bakkt has been quite downbeat about their launch, and data on skew.com have struggled to show any relevance of their option volume. So yes, I think the BAkkt launch has been quite disappointing. EDIT: Apparently a block trade already went trough: 5 options maturing on FEB 20 (expiry 28 Feb 2020) 8,500 strike went togh at a level of 630, corresponding to an implied level of 65.15% with the future at 8220. This implied level is totally compatible with the one observed on deribit. Nice!

Okex launched its option market just few days ago. https://www.newsbtc.com/2020/01/11/okex-bitcoin-options-trading-now-open-for-all-gets-great-response-from-community/ Specifications of the Okex options : https://okexsupport.zendesk.com/hc/en-us/articles/360037737011-1-OKEx-Options-Introduction FTX the plateform in which Binance recently invested tens of millions $ launched its option market this week-end. https://eng.ambcrypto.com/bitcoins-option-trading-hits-1-million-volume-2-hours-after-ftxs-successful-launch/ specifications : https://help.ftx.com/hc/en-us/articles/360038094432-Options-Explainer

Thank you for these updates. Very interesting seeing new competition in the market heating up. Of course one big question mark is the accessibility of these markets for institutional and private customers and their adherence to KYC/AML regulations. Deribit is having some issue on the matter as we speak and they are going to transfer to Panama (effectively cutting out every institutional clients.   Ps. Out of merits now! Will provide as soon as I get some!