Bitcoin derivatives

The most straight-forward bitcoin derivatives are futures and options. Both types of contracts allow for different strategies of which some are very interesting for bitcoin holders that want to earn more money with their stack.

Futures

A future contract is simply put a contract that obliges the buyer of the contract to purchase the underlying asset (in this case bitcoin) at a predetermined future price and date from the seller. Settlement could be 'physical': bitcoins are sent at settlement date, or the price difference between future price and spot at the settlement time can be settled in dollars.

Selling a future

Suppose we are holding 10 bitcoins and we want to decrease our exposure by 50%. We could simply sell half our coins for the current spot price. But we could also capture some extra money by selling futures on 5 bitcoins.

Let's say it is currently the 1st of january and bitcoin is trading at 100 000 USD. We look up the future price for end of december and we see it trades at 120 000. This means that we could sell this future, putting our coins on the exchange for margin. This way we lock in an extra 20 000 USD per coin over just selling our coins. If the price of bitcoin goes to 150 000 our future short position will lose, but our coins make up for this. Similarly if bitcoin drops to 50 000 our future position goes up in value, but our coins decrease with the same amount: we are no longer exposed to the price of bitcoin.

Trading options

Calls are contracts that give you the right (but not the obligation) to buy bitcoin at the specified strike price on the expiration date (European style). So if you have the Dec22 120 000 call, this gives you the right to buy bitcoin on the expiration day in december 2022 for a price of 120 000. If bitcoin is trading well above that level, you will most likely exercise this right. But if bitcoin is trading well below the strike level you probably will not. A put option is the right to sell bitcoin at the specified level and on the specified date.

So the first thing that might come to mind is to use options for bullish or bearish bets. And while this is definitely possible, options are actually far more useful than that. Properly structures option trades allow you trade the implied volatility of bitcoin without being exposed to the price risk. We call these strategies 'delta-neutral' and they need proper hedging with either futures or coins. Delta is the term used for sensitivity to the price of the underlying. Delta neutral thus means: not sensitive to the price (of bitcoin).

Selling covered OTM calls

Similar to selling futures, you can also sell calls in the right proportion to your holdings. But instead of losing all exposure to the price, we merely cap our upside with this play. Obviously you are compensated for this, by receiving premium. Let's say bitcoin is trading at 100,000 USD and we sell the 150 000 call one month out. At the moment of selling we receive the premium, this is our max profit. Now if bitcoin trades below 150,000 USD at expiration date the calls will be worthless and we keep our bitcoin. If bitcoin trades at 160 000 for example the buyers of the calls might exercise them and we have to sell our bitcoin at 150 000 to them in that case.

Trading ATM straddles

If we have the call and the put both with the same strike that corresponds with the current price, we are talking about the straddle. Why would we want to buy/sell the straddle? The call has a positive delta and the put an equal negative delta, so what would be the idea behind this? For one, when we buy the straddle we buy 'vega'. Vega is the sensitivity to implied volatility. This means that the value of the straddle will increase if implied volatility moves higher. All calls and puts have positive vega. That is to say, both calls and puts profit from increased (implied) volatility. By holding a delta-neutral straddle, we are not exposed to the price of bitcoin, but we are exposed to the implied volatility of bitcoin.

Selling OTM puts

If we sell puts with a strike price lower than the current spot price of bitcoin, we sell someone else the right to sell bitcoin to us on this lower strike price. So we receive premium and if the price of bitcoin dips lower than the strike price, we might be 'forced' to buy bitcoin at this price. This is a nice strategy if you think bitcoin will always restore from dips and you want to make some extra income.

Options allow you to:
  • trade implied volatility;
  • make leveraged directional bets;
  • hedge downside risks;
  • receive income by limiting your upside;

One of the most well-known and respected parties that offers options and futures trading is Deribit (not for US citizens).