If you're new to crypto call options, the idea of them expiring worthless may sound daunting. Although mostly used as a way to hedge against near-term market volatility, many traders today also use call options to make bold speculations in the crypto market. Thanks to perks like affordable leverage and premiums that cost a fraction of spot trades, it's no wonder call options are gaining popularity among bullish crypto traders looking to reap lucrative gains.
Keen to learn more about the mechanics driving crypto call options? From diving into the deep-seated mechanics of crypto call options to illustrating how call options work with a BTC long call option example, here's all you need to know when it comes to understanding what are crypto call options.
TL;DR
Crypto call options are financial derivatives that give the holder the right to buy an underlying crypto asset at a predetermined strike price.
Buying a call option is like betting on the asset's price rising, while selling a call option involves taking on the obligation to sell the asset at the agreed strike price.
The key difference between TradFi call options and crypto call options is the amount of volatility surrounding each market, which can lead to amplified implied volatility levels.
Advantages of trading crypto call options include leverage and risk management, while the risks include time decay and market volatility.
Crypto traders often buy call options because they have a bullish sentiment or want to hedge against potential price drops.
What is a call option?
A call option is a financial derivative that gives the holder the choice to purchase an underlying asset before a specific expiration date at a predetermined price. This is also known as the option's strike price. Unlike spot trading where you outright own and trade the asset, a call option is a derivative that allows you to speculate on future price movements of the underlying asset with lesser upfront capital. This capital efficiency and flexibility ultimately makes crypto call options a popular choice when it comes to trading crypto derivatives.
Key terms to know
Before diving into how crypto call options work, let’s first familiarize ourselves with a few key terms typically used when discussing options.
Strike price: The predetermined price at which the option holder can buy the underlying crypto asset.
Premium: The price paid for purchasing the option contract.
Expiration date: The date by which the option must be exercised, or it becomes worthless.
Underlying asset: The coin or token that the call option is based on.
Call options explained: how do call options work in the crypto market?
What happens when you buy calls?
From the buyer’s point of view, purchasing a call option is like betting that the price of the underlying coin or token will rise in the future. By paying the premium upfront, the buyer secures the right to buy the asset at the strike price, regardless of how high the market price rises. If the market price exceeds the strike price before the option expires, the buyer can exercise the option to buy at the lower price and sell it at the current market price, making gains in the process.
What happens when you sell calls?
For the seller who chooses to write the call options, selling a call option means taking on the obligation to sell the underlying asset to the buyer at the strike price if the buyer decides to exercise the option. Sellers receive the credited call premiums upfront but risk having to sell the asset below its last traded value if the asset’s price is above the strike price at expiry.
Differences between crypto and TradFi call options
While they may seem similar, the key difference between crypto call options and those in traditional financial markets is the underlying asset surrounding these derivatives. While both types of options work similarly in terms of mechanics, cryptocurrencies are typically more volatile than stocks, which can affect the pricing of options contracts when it comes to factors like implied volatility. Additionally, liquidity and regulation vary between the two markets, with crypto markets generally being less regulated and more prone to sharp price swings.
Example of a crypto call option trade
Interested in seeing how a typical long call crypto option trade will play out? Let's use the following Bitcoin options derivatives as a step-by-step example for you to consider.
Since the recent early October 2024 market decline, Bitcoin prices have been experiencing a minor correction as the market is on a downtrend. To calculate possible strike prices to purchase our long BTC call options at, we can make use of technical analysis tools and trading indicators to get a better grasp of the existing market sentiment. Applying the Fibonacci retracement tool, we can see that Bitcoin prices may be showing some signs of support at the 0.5 retracement area. This is supported by the Relative Strength Index indicator, which shows that BTC is close to being considered oversold at its 44.5 reading. As such, bullish crypto traders may want to consider long call options as a form of bullish speculation.
When it comes to strike prices and specific expiry dates, let's explore at-the-money (ATM) call options that will be expiring on November 8, 2024. By referencing our Bitcoin options chain, we can see that a BTC call option with a November 8 expiry date and strike price of $60,000 will cost you about 0.077 BTC in premiums. This is equivalent to about $4,600. By forking over this amount in call premiums, you'll have the right to buy one Bitcoin at $60,000 should the last-traded price of BTC be above $60,000 on November 8, 2024.
Calculating potential gains and losses
If BTC trades at $70,000 at expiry, your net gains would be equal to about $5,400 after subtracting the initial premiums paid. Conversely, if BTC trades below $60,000 at expiry, the Bitcoin call option ultimately goes to waste as it expires out-of-the-money (OTM) and becomes worthless.
This example illustrates the value of crypto call options. Although your potential upside is theoretically as high as the underlying asset trades at by expiry, your downside risk is capped at the amount you paid for the call option.
Popular call option strategies among crypto traders
Let's look now at some of the main call option strategies crypto traders apply.
Long call
The long call is a basic single leg crypto option strategy that involves buying a call option when you expect the price of the underlying cryptocurrency to rise. As previously demonstrated, it’s a straightforward, bullish strategy that offers unlimited upside potential while capping your losses to the premium paid. A long call is ideal for traders who are confident in a price rally but want to limit the initial capital they've committed to the speculative trade.
Covered call
In a crypto covered call strategy, you sell a call option on a cryptocurrency you already own. This strategy is typically used to generate passive gains from your crypto holdings by collecting call premiums from the option sale. However, if the price of the cryptocurrency rises above the strike price, you’ll be obligated to sell the asset at the strike price, potentially missing out on some gains.
Protective call
A protective call is an options hedging strategy where you buy a call option to hedge against potential losses in a short position. If the market moves against your short position and the price of the cryptocurrency rises, the call option will increase in value, offsetting some of your losses.
Straddle
A straddle is a multi-leg options strategy that involves buying both a call option and a put option at the same strike price and expiration date. This strategy is useful when you expect a large price movement but aren’t sure whether the price will go up or down. The potential gain is high if the price moves significantly, but you’ll incur a loss if the price stays relatively stable within the expected time frame.
Advantages of trading crypto call options
Ability to leverage
One of the main advantages of trading call options in crypto markets is leverage. With a relatively small upfront cost, call options effectively give you control of a larger position in an underlying asset. This allows traders to amplify potential gains without needing to commit large amounts of capital upfront.
Risk management thanks to premiums paid
Call options provide an excellent way to manage risk. Since the most you can lose is the premium, your downside is limited, even in volatile crypto markets. This makes call options attractive for traders who want exposure to potential price increases while mitigating the risk of large losses.
Risks of crypto call options
Time decay in crypto options
Time decay, or theta, is a key risk in options trading. As the expiration date approaches, the value of the option erodes, particularly if the underlying asset’s price doesn’t move significantly. In volatile crypto markets, this risk of time decay can be amplified when you choose to trade crypto call options with short expiration periods. This can ultimately leave traders with little time to react and exposed to high amounts of risk.
Market volatility
Crypto markets are notoriously volatile, which can lead to significant fluctuations in the price of options thanks to amplified implied volatility levels. While this market volatility can create opportunities, it also increases the risk that the price of the underlying asset will move against your position, leading to a loss.
When should you buy a crypto call option?
Bullish sentiment in the crypto market
Call options are ideal for traders who believe the price of a cryptocurrency will rise. If you’re bullish on an asset like Bitcoin or Ether and expect a significant price increase in the near future, buying a call option allows you to capitalize on that movement with limited risk.
Hedging against price drops
Call options can also be used as part of a hedging strategy. For example, if you hold a significant position in a cryptocurrency and are concerned about a potential price drop, you could buy a call option to limit your losses while maintaining the potential to make gains if the market rebounds.
Final words and next steps
Crypto call options offer an exciting way to lock in gains from price movements in the crypto market while managing risk effectively. Whether you're looking to take advantage of a potential price rally or hedge against downturns, understanding the mechanics and strategies of call options is essential. As you explore trading crypto call options, consider using educational resources to build your knowledge and enhance your trading strategy.
Keen to learn more about advanced crypto option strategies involving calls? Check out our guide to the options wheel strategy and strangle strategy. These guides will likely be helpful if you're keen to brush up on your crypto options strategies and trading crypto options before committing to one of the top crypto options trading platforms.
FAQs
A call option gives you the right to buy the underlying cryptocurrency, while a put option gives you the right to sell it at a predetermined price.
No, your maximum loss is limited to the premium you paid for the option. However, there may be excessive losses if you write naked call options and they unfortunately expire in-the-money.
The value of the option decreases as the expiration date approaches thanks to theta decay. This is especially so if the underlying asset's price hasn't moved favorably.
Since you're not able to exercise the call option, it expires worthless, and your loss is limited to the premium you paid.
The strike price should reflect your expectations of where the underlying asset's price will move. An ATM call option increases the likelihood of making gains but would cost more in terms of upfront premiums paid while the reverse is true for OTM calls.
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