In-depth study of options trading: from basic concepts to practice

The Essence of Options Trading

Options are derivative financial instruments that give traders the right, but not the obligation, to take certain actions with an asset. The main difference between options trading and regular trading is that the participant can opt out of the deal, losing only the premium paid.

The main advantages of options:

• Flexibility in making decisions about buying or selling assets
• The possibility of earning profit without owning the underlying asset
• Risk management through fixed maximum loss
• Trading the right to an asset, not the asset itself

Imagine you see a cryptocurrency asset that interests you, such as Bitcoin (BTC), but you are unsure about its future movement. Instead of making an immediate purchase, you can buy an option - a contract that allows you to buy or sell this asset at a predetermined price within a specific period. In this case, you pay a premium (cost of the contract), but you are not obligated to execute the contract if the market conditions do not suit you.

Main Types of Options Contracts

Call options: betting on growth

A call option gives the holder the right to purchase the underlying asset at a fixed price (strike price) before a specified date. Traders buy call options when they anticipate an increase in the asset's value.

Examples of underlying assets:

• Cryptocurrencies: Ether (ETH), BNB, Tether (USDT) and other altcoins
• Traditional assets: company stocks, stock indices, commodities

Profit mechanism: if the asset price rises above the strike price, the holder can exercise the contract and receive the difference. Alternatively, if the price of the option itself increases before expiration, the contract can be sold to another trader for a profit without executing the transaction with the underlying asset.

Put options: protection against decline

A put option provides the right to sell an asset at a fixed price until the expiration date. This is a tool for traders who expect a decrease in the asset's value or want to hedge existing positions.

When the market price falls below the strike price, the owner of the put option can:

• Execute the contract and sell the asset at a higher strike price
• Sell the option contract itself for a profit if its value has increased.

Key Components of an Option Contract

Strike price

The strike price is a predetermined price at which a participant can buy ( for a call option ) or sell ( for a put option ) on the underlying asset. This price remains unchanged throughout the duration of the contract, regardless of how the market price moves.

The relationship between the strike price and the current market price critically impacts the value and attractiveness of the contract.

Expiration date

The expiration date is the final date after which the contract becomes void and cannot be executed. The duration of options varies from a few days to several years, depending on the type of contract and market conditions.

Prize: price of rights

The premium is the fee that a trader must pay to obtain the right to exercise an option. This is a non-refundable commission that represents the cost of the contract.

Factors affecting the size of the premium:

• Current market price of the underlying asset
• The price volatility of the asset (higher volatility increases the premium)
• The distance between the strike price and the current price
• The remaining time until the expiration date (, the more time there is, the higher the premium )

The Difference Between American and European Options

One of the key aspects of options trading is understanding the types of contracts based on the geographical market.

American options are characterized by greater flexibility. They can be exercised at any time up to the expiration date. This gives the holder maximum control over their position.

European options have stricter exercise conditions. A European option can only be exercised on the expiration date of the contract, which does not allow for early exercise. Despite this limitation, a European option often ends up being cheaper in premium due to less flexibility.

In most cases, traders make a profit not by executing contracts, but by buying and selling the option contracts themselves while they are still valid. This means that the difference between the types of options rarely affects practical trading.

Conditions for Option Profitability

Three key conditions are used to assess the value of an option and to make trading decisions:

In The Money (ITM — In The Money): the option has intrinsic value

• For a call option: market price > strike price
• For a put option: market price < strike price

At the Money (ATM — At The Money): the market price is approximately equal to the strike price, the intrinsic value is minimal.

Out Of The Money (OTM — Out Of The Money): an option has no intrinsic value, although it may have time value.

• For call options: market price < strike price
• For a put option: market price > strike price

Greeks of Options: Measuring Risk

Greeks are mathematical indicators that help traders assess how various factors influence the price of an option and its risk.

Delta (Δ): indicates how much the price of an option will change when the underlying asset moves by $1. The value of delta ranges from 0 to 1 for call options and from -1 to 0 for put options.

Gamma (Γ): measures the rate of change of delta. A high gamma means that delta will change quickly with small movements of the asset, which increases uncertainty.

Theta (θ): reflects time decay — how much the price of an option decreases as the expiration date approaches. For the option holder, theta is usually negative (the value decreases).

Vega (ν): shows sensitivity to changes in market volatility. Increased volatility typically raises the value of the option, as there is a higher likelihood of price movement.

Rho (ρ): measures the impact of interest rate changes on the price of an option. A positive rho indicates an increase in value with rising rates, while a negative rho indicates a decrease.

Trading Contracts Against Execution

A critically important understanding for options market participants: most profits come from trading the contracts themselves, rather than from their execution.

Instead of waiting for the expiration date, the trader can:

1. Acquire an option contract at one price
2. Sell the same contract at a higher price if its value has increased.
3. Profit from the change in the value of the contract without making any transactions with the underlying asset.

This allows earning income from market volatility and changes in the supply and demand conditions for the contracts themselves.

Size and Contract Calculations

The size of an options contract is determined by the type of underlying asset. For stocks, one contract typically covers 100 shares. For cryptocurrency options, index options, and commodities, the size can vary significantly.

Before starting trading, it is essential to carefully check the contract specifications to fully understand the volumes and risks.

Calculations in most markets are conducted in monetary terms: instead of the physical delivery of the asset, the parties exchange its monetary value, which simplifies the process and eliminates practical difficulties.

Practical Recommendations for Beginner Traders

Before starting options trading, it is necessary to:

• Fully understand the mechanisms of call and put options
• Study the influence of each Greek parameter on the contract price
• Understand the difference between American and European options for the chosen instrument
• Start with small volumes and demo trading
• Always use risk management strategies
• Do not risk amounts that you cannot afford to lose

Options trading offers powerful opportunities for hedging, speculation, and developing complex investment strategies. However, like all financial instruments, it requires a deep understanding and discipline in risk management. European options and American options have their advantages depending on the trader's strategy.

Continuous learning and practice are the keys to successful trading in options on cryptocurrency and traditional financial markets.