On Deribit it is possible to both buy and sell any of the cryptocurrency options available, including the bitcoin call options.
Apart from any trading fees, an option contract is a zero sum game. Any profit made by a call option buyer will result in an equal loss made by the call option seller. Conversely any loss made by a call option buyer will result in an equal profit made by the call option seller.
The differences in the PNL calculations that we went through in lecture 4.2 mean the profit/loss chart for both buyer and seller are a little different to the dollar call options discussed in section 3.
Let’s study the option we looked at in example 1 in lectures 4.2 and 4.3. This was a bitcoin call option with a strike price of $12,000 and a premium of 0.05 BTC.
The profit/loss of the call option buyer is shown in blue, and in red we can see the profit/loss of the call option seller. At each level of underlying price, the PNL lines for buyer and seller are an equal distance away from the x-axis, but on opposite sides, one positive and one negative.
Where each line crosses the x-axis represents the breakeven point, i.e. the point at which $0 profit or loss is made. The buyer and seller of the option share the same breakeven point as well (this is ignoring any trading fees). As we calculated in the previous lecture, the breakeven point is $12,631.58.
Fixed profit for the seller
The profit for the seller is still fixed to the premium collected, just as the buyer’s risk is fixed to the premium paid. With the bitcoin options on Deribit this premium is a fixed amount of bitcoin, rather than a fixed amount of dollars.
Risk for the seller
For options that use dollars as collateral, you may remember that:
“When the underlying price increases above the strike price, the potential profit for the call option buyer is unlimited, and the potential loss for the call option seller is also unlimited.”
Both of these statements of course are referring to dollar amounts.
This is where the differences in cryptocurrency call options on Deribit will begin to stand out. The profit of the buyer of a bitcoin call option is actually capped, at 1 bitcoin (minus the premium paid). Similarly the loss of the seller of a bitcoin call option is capped at 1 bitcoin (minus the premium collected).
No matter how high the bitcoin price goes, a single bitcoin call option can be worth at most 1 bitcoin. This is true of course for any asset, because the right to buy an asset cannot logically be worth more than the asset itself. Why would anyone pay for the right to buy an asset, if they could purchase the asset for less than the cost of that right?!
Remember, as we touched on in lecture 4.1, the reason this difference exists with the cryptocurrency call options on Deribit, compared to the dollar options we discussed previously, is because here we are using the asset itself as collateral. I.e. We are using the base currency (bitcoin) as collateral, rather than the quote currency (dollars). If we were instead trading bitcoin options with the quote currency of dollars as collateral, as is the case on the CME for example, then all the same rules and calculations we discussed in section 3 would apply, with none of the differences we’re covering in section 4.
To reiterate, the differences we’re working through in section 4, are not specific to bitcoin. They arise simply because we are using the asset itself as the collateral. The same would apply if we were using Facebook shares as collateral for trading Facebook options, or Amazon shares as collateral for Amazon options. With shares this would of course be impractical, but as bitcoin is a divisible currency, it works just fine.
Getting back to the risk for the seller of the bitcoin call option, they can still lose far more than they collected in premium, but it is capped at 1 bitcoin (minus the premium collected). Even though there is technically a cap on the risk when measured in bitcoin, it is still advisable for new traders to make themselves fully aware of the risks before selling cryptocurrency options. This is even more the case with cryptocurrency put options, which we will cover in section 6.
The effect of time
Time has the same effect on cryptocurrency options as it does on the options discussed in section 3. Time works against the buyer as it puts a time limit on them being correct. For the seller, this works in their favour. Every day that passes, the option will lose a little bit of it’s value. The more time that passes without the underlying price increasing, the more value the call option will lose, and the more profit the call option seller will be making.
When buying a cryptocurrency option, the buyer is required to pay the entire premium up front to open the position. As the maximum the long call option can lose is the premium paid, this is the only capital the buyer needs to use.
The maximum loss for the seller though can be more than they collect in premium, so they are required to keep an extra amount in their account to cover potential losses. This amount is called their margin, and is calculated according to formulas that you will find on the exchanges website.
Selling a cryptocurrency call option is the opposite of buying a cryptocurrency call option. Both the risk and reward are reversed. Any profit for the seller is a loss for the buyer, and vice versa.
Buying a bitcoin call option is a bet that the underlying price of bitcoin will increase, and selling a bitcoin call therefore is a bet that the underlying price of bitcoin will not increase. Or at least not increase beyond the strike price.
The seller of a bitcoin call option has a limited profit potential. Their maximum profit is the premium they collected for the call.
As we’re using bitcoin itself as collateral instead of dollars, the seller’s risk does have a cap when measured in bitcoin. However, they can still potentially lose far more than they collected in premium. The seller must also be familiar with the margin requirements for short option positions.
When you’re brand new to options, it’s best to wait until you’re confident you have sufficient knowledge of the risks before selling options.