On Deribit it is possible to both buy and sell all the cryptocurrency options available, including the bitcoin put options. 

Apart from any trading fees, an option contract is a zero sum game. Any profit made by a put option buyer will result in an equal loss made by the put option seller. Conversely any loss made by a put option buyer will result in an equal profit made by the put option seller.

The differences in the PNL calculations that we went through in lecture 6.2 mean the profit/loss chart for both buyer and seller are a little different to the dollar put options discussed in section 5.

Let’s study the option we looked at in example 1 in lectures 6.2 and 6.3. This was a bitcoin put option with a strike price of $15,000 and a premium of 0.1 BTC.

The profit/loss of the put option buyer is shown in blue, and in red we can see the profit/loss of the put 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 $13,636.36.

Fixed profit

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 put options that use dollars as collateral, you may remember that the maximum loss is limited to:

= Strike – Premium

This maximum loss for the put option seller would occur if the underlying price at expiry is zero (or very close to it).

For sellers of cryptocurrency put options that use the cryptocurrency itself as collateral, this situation is drastically different. The difference we’re about to cover is probably the most important difference to make sure you’re aware of if you’re considering selling cryptocurrency options.

When selling a cryptocurrency put option that uses the cryptocurrency itself as collateral, the maximum loss, measured in the cryptocurrency, is unlimited! This ‘measured in the cryptocurrency’ qualifier is the important part, because it’s the cryptocurrency that our account balance is stored in. The profit/loss is still calculated in dollars first, so the maximum loss in dollars still has the same cap of:

= Strike – Premium

However, the collateral we’re using to support the position is not stored in dollars, it’s stored in the cryptocurrency, such as bitcoin. As the underlying bitcoin price decreases, the amount of bitcoin required to pay each dollar owed to the put option buyer increases.

For example with bitcoin trading at $10,000, every dollar we as a put option seller owe the put option buyer requires us to pay them 0.0001 BTC, or one ten thousandth of a bitcoin. However if the price of bitcoin falls to say $5,000, every dollar we as the put option seller owe the buyer requires us to pay them 0.0002 BTC, or one five thousandth of a bitcoin. Not only do we owe them more bitcoin per dollar, but because the price has fallen further, we also owe them more dollars in total, further amplifying the losses measured in bitcoin. 

We will cover some more specific examples in the next lecture, but the important thing to remember is that, unless hedged, selling a cryptocurrency put option has an unlimited maximum loss when measured in the cryptocurrency. You may notice I said ‘unless hedged’ there. We will also cover hedging in later lectures, which comes in useful if you want to avoid this type of unlimited risk to your account.

The effect of time

Time has the same effect on cryptocurrency put options as it does on the put options discussed in section 5. 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 decreasing, the more value the put option will lose, and the more profit the put option seller will be making. 

Margin

When buying a cryptocurrency option, this will require the buyer to pay the entire premium up front to open the position. As the maximum the long put 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 far more than they collect in premium, and indeed has no limit as we’ve just touched on, so they are required to keep an extra amount in their account to cover potential losses. This amount is their margin, and is calculated according to formulas that you will find on the exchanges website.

The amount of margin required to hold a short option position will change over time as the value of the position changes. For a put option, as the underlying price decreases, the margin required to continue holding the short put position may increase. As we’ve discussed the potential losses for a short put are unlimited, so this can quickly become more than you initially wanted to risk. You should have a defined plan before entering any trading position, but this is particularly the case for shorting cryptocurrency put options for this reason.

In summary

Selling a cryptocurrency put option is the opposite of buying a cryptocurrency put 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 put option is a bet that the underlying price of bitcoin will decrease, and selling a bitcoin put therefore is a bet that the underlying price of bitcoin will not decrease. Or at least not decrease beyond the strike price.

The seller of a bitcoin put option has a limited profit potential. Their maximum profit is the premium they collected for the put.

As we’re using bitcoin itself as collateral instead of dollars, the seller’s risk has no cap when measured in bitcoin. They can potentially lose far more than they collected in premium. The seller must also be familiar with the margin requirements for short option positions on the exchange they are using.

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. Option sellers should also study how to mitigate these risks using spreads, stops, hedging, or all of the above. We will come onto these later in this course as well.