In the space of a few years, Bitcoin has gone from something couch potatoes trade for a slice of pizza via a Reddit thread, to one of the hottest commodities on the market.
In the last five years, total daily transactions in the Bitcoin market has risen 900% from 33800 to over 335,000 according to CoinDesk. As the cryptocurrency has become more popular, so have the instruments to trade it. More exchanges are opening up, and Bitcoin ETFs may be on their way. But one tool that is already up and running is Bitcoin options. For years, Bitcoin option trading was not regulated in the U.S. but this looks set to change with a recent decision by the Commodity Futures Trading Commission (CFTC). (See also: Bitcoin Pizza Day: Celebrating the $20 Million Pizza Order)
However, trading Bitcoin options is not for the faint-hearted. They are extremely volatile and very expensive. (See also: Why Aren't Hedge Funds Interested in Bitcoin?)
Bitcoin daily transactions
How bitcoin options trade
Bitcoin options trade the same as any other basic call or put option where an investor pays a premium for the right - but not obligation - to buy or sell an agreed amount of Bitcoins on an agreed date. Additionally, various offshore exchanges offer binary options, where traders bet on a yes/no scenario. For example, whether or not Bitcoin will rise or fall, or whether or not it will be above or below a specific price on a specific day.
Why are they so expensive?
One major difference in trading Bitcoin options at the moment is the price. Bitcoin is one of - if not the most - volatile asset trading at this time, meaning to buy an option is very expensive. Take a look at the below pricing screen for June 7, 2017.
An important tool in pricing an option is implied volatility. As IV rises, so does the price of an option. The above pricing screen for options with a 30 June (22-day) expiry show implied volatility ranging from 90% to above 200% for strike prices from 2000 to 3200. So how expensive is this? VERY! On October 2, 2017, for example, the 30-day IV for the S&P 500 was nearing record lows at 6.7%, according to data from the Options Industry Council, and even in the height of the Great Recession, IV did not reach the types of levels we are now seeing in Bitcoin trading. On November 14, 2008, two months after the collapse of Lehman Brothers short-term IV reached record highs of 65%.
Bitcoin options trading in the U.S.
After months of lobbying, Bitcoin options are soon to be legal in the U.S. On October 2, 2017, the Commodity Futures Trading Commission (CFTC) announced the approval of LedgerX for clearing derivatives. LedgerX, a digital-currency platform, announced in May it had raised $11.4 million via its parent company Ledger Holdings in the hope the CFTC decision would rule in its favor, which it did. "A U.S. federally-regulated venue for derivative contracts settling in digital currencies opens the market to a much larger customer base," Paul Chou, LedgerX CEO said in a press release.
CEO Chou said he expects the company to begin Bitcoin option trading in the fall and hopes to extend to Ethereum later in the year.
The push for options was given further validity when in October the Chicago Mercantile Exchange (CME) announced it plans to launch Bitcoin futures in the fourth-quarter of 2017. "Given increasing client interest in the evolving cryptocurrency markets, we have decided to introduce a bitcoin futures contract," Terry Duffy, Chief Executive Officer of the CME said in a statement.
As popularity in the cryptocurrency grows the products to trade the underlying asset will widen. Despite being relatively new, Bitcoin option trading is available in a handful of countries, which will soon include the U.S.
However, for those looking to dabble in options be warned, they are expensive and volatile so buckle up!