Bitcoin Options: Yield Opportunities or Philosophical Gamble?
You must know by now that my favourite topic to write on is Bitcoin 🙃
This week I was scrolling through news, as I often do, and I found this article: “BlackRock’s Spot Bitcoin ETF Receives Green Light for Options Trading”. I have to say that it made me think what does it really mean for the future of bitcoin. Not only the philosophy behind it, but also the possibility of a future bitcoin price bubble. Then I thought of you, my readers, and how do you take this news, what it means for you and will this make you “trust” bitcoin more or stay away from it. In my usual style, I’d like to start explaining basic concepts around options trading, a brief history and some analogies that should help demystify this speculative investment mechanism.
A brief history of options:
Tulip mania, also known as the Dutch tulip bubble, occurred in 17th-century Holland when options contracts were used to speculate on tulip bulb prices. This event is considered the first recorded economic bubble, with tulip bulb prices reaching extremely high levels before crashing in 1637.
The modern options market began in 1973 with the creation of the Chicago Board Options Exchange (CBOE), which standardised option contracts and created a secondary market for trading them. The CBOE was the first exchange to list cash-settled options, which allowed for the trading of options on stocks and indices without the need for underlying securities.
What is options trading?
In the world of finance, an option is a contract that gives the holder the right (but not the obligation) to buy or sell an asset at a specific price within a certain time frame. There are two main types:
Call options: these give you the right to buy an asset at a set price in the future.
Put options: these give you the right to sell an asset at a set price in the future.
Options allow traders to speculate on the future price of bitcoin without necessarily owning the underlying asset. Popular platforms like Deribit and LedgerX have made bitcoin options trading accessible to a wider audience.
BlackRock, through its iShares Bitcoin Trust (IBIT), offers a way to invest in and trade Bitcoin, including options. The iShares Bitcoin Trust is an exchange-traded product (ETP) that gives investors direct exposure to bitcoin's price movements. However, the specific process of buying and selling bitcoin call options, including from BlackRock, involves several steps and considerations, such as opening an options trading account, understanding the mechanics of options trading, and selecting the right platform or exchange to trade these options.
Why use Bitcoin Options?
There are several reasons why people might choose to engage with bitcoin options:
Hedging: hedging with bitcoin options is like buying insurance for your bitcoin holdings. Let's say you own 1 BTC worth $60,000, but you're worried the price might drop. You could buy a put option with a strike price of $58,000, expiring in 3 months. If the price of BTC falls below $58,000, you can exercise your option to sell at $58,000, limiting your loss. If bitcoin's price stays above $58,000, you let the option expire and only lose the premium you paid for the option.
Speculation: traders use options to make leveraged bets on bitcoin's price movements. For example, if a trader believes bitcoin's price will rise significantly, they might buy call options. These options cost less than buying bitcoin outright, but offer the potential for much higher returns if the prediction is correct. However, if the prediction is wrong, the trader only loses the premium paid for the options.
Yield generation: this involves strategies to earn additional income from bitcoin holdings. Two popular methods are:
Selling covered calls: If you own bitcoin, you can sell call options against your holdings. You collect a premium for selling the option. If the price stays below the strike price, you keep both the premium and your bitcoin. If it goes above, you might have to sell your BTC at the strike price, but you still keep the premium.
Selling cash-secured puts: This involves selling put options and setting aside the cash to buy bitcoin if the option is exercised. You collect a premium for selling the option. If bitcoin's price stays above the strike price, you keep the premium. If it falls below, you have to buy bitcoin at the strike price.
Institutional interest: as the Bitcoin market matures, it's attracting more institutional investors like hedge funds, asset managers, and even some banks. These entities often use complex strategies involving options.
Working example of bitcoin options trading
How would this work assuming I have 1 BTC worth $60,000 and decide to engage in leveraged call option selling? Here's how it might play out:
I decide to sell call options at a strike price of $65,000, expiring in 1 month. I’m betting that bitcoin's price won't exceed $65,000 by expiration date.
Let's say the exchange offers 5x leverage. This means I can control positions worth 5 times my collateral.
The Trade:
I sell 5 call option contracts, each representing 1 BTC.
The premium for each contract might be around $1,500 (this would vary based on market conditions).
Total premium received: 5 x $1,500 = $7,500
Collateral: Generally, a deposit is needed, a percentage of the total value of the options contract, which is the option margin. This is a form of security to cover potential losses from the options trade. The exact percentage varies by exchange but typically ranges from 20-40%:
The exchange might require 20% of the position size as collateral.
Position size: 5 BTC x $60,000 = $300,000
Required collateral: $300,000 x 20% = $60,000 (value of 1 BTC)
Potential Outcomes:
Scenario A: Bitcoin price stays below $65,000
The options expire worthless.
I keep the entire $7,500 premium.
Return on collateral: 12.5% in a month
Scenario B: Bitcoin price rises to $70,000
The options are $5,000 in-the-money each.
My loss per contract: $5,000 - $1,500 (premium) = $3,500
Total loss: 5 x $3,500 = $17,500
My 1 BTC is now worth $70,000, but I've lost $17,500 on the options trade.
Scenario C: Bitcoin price skyrockets to $75,000
The options are $10,000 in-the-money each.
My loss per contract: $10,000 - $1,500 (premium) = $8,500
Total loss: 5 x $8,500 = $42,500
My 1 BTC is now worth $75,000, but I've lost $42,500 on the options trade.
You might think that I need to own BTC in order to engage in options trading, but that’s not the case. Just like in traditional market, I can buy call or put options even if I don’t own the underlying asset, in this case bitcoin. This is often called "trading options on margin" or simply "trading naked options." This is highly speculative and, in my opinion, akin to gambling. Why is that? Let’s see:
I've got $10,000 in my account, and I'm ready to make a move. I find a call option with a strike price of $65,000, expiring in one month. The premium is $2,000 per contract - steep, but if I'm right about this price movement, it'll be worth it. One scenario: my prediction comes true, bitcoin's price shoots up to $70,000 by the expiration date and my option is now worth $5,000 - the difference between the current price and my strike price. After subtracting the $2,000 I paid for the option, I'm left with a $3,000 profit. A 150% return on my investment! Sounds great, right?
Let’s consider the other possibility. What if I'm wrong? If Bitcoin's price doesn't reach $65,000 by the expiration date, my option will expire worthless. In this case, I'll lose the entire $2,000 I paid for the option.
The crucial point to note is that by selling options, you're creating leverage. With leverage comes risk. If the price moves against you, the losses can be significant. But when you're bullish and the price moves up, the gains can be substantial.
Why bitcoin options?
The fundamental difference between BTC and stock market options lies in supply dynamics. In the stock market, companies can issue more shares, or split existing shares, effectively "printing" new shares. This increases the supply, which can put downward pressure on stock prices. Institutions can influence these decisions, making the stock market's supply dynamics more malleable.
BTC, on the other hand, has a fixed supply. There are a known number of BTC in circulation, and institutions can't print more. This scarcity is a key characteristic of BTC and creates a different market dynamic compared to stocks.
When institutions or investors predict a rise in BTC price, they might generate lots of call options, expecting BTC to increase in value. If BTC indeed rises, as predicted, these institutions will need to buy more BTC to fulfill their obligations from the call options they've sold. This increased demand can further drive up the price of BTC.
However, the key difference is that in the stock market, if the price moves against the prediction, institutions can often hedge their positions by buying more shares or exercising the options they've sold, without significantly impacting the overall supply. In the BTC market, since they can’t buy more bitcoin as the supply is fixed, there's a built-in mechanism of increased demand due to options obligations, which can further push the price up, creating a self-reinforcing cycle and possibly a BTC price bubble.
How bitcoin options differ from bitcoin's original philosophy
While options might seem like a natural evolution of Bitcoin's financial ecosystem, they represent a significant departure from its original ethos. Bitcoin was meant to be a peer-to-peer electronic cash system, free from intermediaries. Options trading often involves centralised exchanges and complex financial products.
What happened to being your own bank? The core idea of Bitcoin was to eliminate the need for trusted third parties. Options trading reintroduces reliance on others, whether it's exchanges, brokers, or counterparties. As yield-seeking behaviour grows, it may shift Bitcoin's narrative from a tool for financial freedom to just another speculative asset.
Bitcoin was often envisioned as digital gold, a long-term store of value, whilst options trading often focuses on short-term price movements and quick profits, and it doesn't add any intrinsic value to the Bitcoin ecosystem.
My take on BTC options trading
I tried very hard to explain a trading mechanism that I don’t believe in and perhaps don’t see the need for, especially when it involves bitcoin. On one hand, these new financial products may increase bitcoin's utility and attract more users to the ecosystem. On the other, they risk undermining the very principles that made bitcoin revolutionary in the first place. Bitcoin's inception was fuelled by a speculative bubble, driven by over-leveraging. The very tools that facilitated this phenomenon are now being used to replicate the cycle. The parallels between the birth of Bitcoin, on the back of 2006 - 2007 crisis, and the current market conditions suggest that the lessons from the past have not been learned, and the cycle may repeat itself, with potentially catastrophic consequences.
Ultimately, each bitcoin user must decide for themselves how to engage with these new financial tools. Are you using bitcoin as a long-term store of value, aligning with its original mission? Or has it become a vehicle for short-term speculation and yield chasing?
As the bitcoin ecosystem continues to evolve, it's important to reflect on these questions. The choices we make as a community will shape the future of this groundbreaking technology. Will Bitcoin remain true to its roots as a decentralised, sovereign form of money? Or will it be absorbed into the very financial system it was designed to disrupt? The power to decide lies in our hands – and our wallets.
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