Trading cryptocurrencies isn’t just about buying and selling. You can also engage with digital assets without holding them directly. One popular way to do so is through the crypto derivatives market, which includes contracts like futures, options, and perpetual swaps tied to cryptocurrency prices. 

With annual trading volumes surpassing $1 trillion, crypto derivatives have become one of the most active and versatile segments in the crypto space, offering tools to manage risk, speculate on price movements, and hedge positions.

However, before adding crypto options to a trading strategy, it’s important to understand how crypto options contracts work and consider the risks associated with derivatives. In this guide, we’ll tell you what you need to know.

What are crypto options?

Cryptocurrency options are financial contracts that grant traders the right (or "option") to buy or sell a digital asset at a specific price before a set expiration date. While these contracts are legally binding for those who sell (or "write") them, holders can decide whether to use (or "exercise") the option. 

Unlike spot cryptocurrency trading, which involves direct ownership of digital assets, options represent potential ownership rights. Because their value is derived from cryptocurrencies, options belong to a financial category known as "derivatives." The flexibility allows traders to speculate on price movements without needing to custody cryptocurrencies in exchange accounts or wallets. Instead, crypto options exchanges hold these contracts on the traders’ behalf.  

Cryptocurrency options come in two types: call options and put options. Each is suited to different market outlooks:

• Call options give holders the right to buy a cryptocurrency at a predetermined price before the contract expires. Calls are generally associated with upward (or bullish) market expectations and gain value as the underlying cryptocurrency price rises. 
• Put options allow traders to sell a cryptocurrency at a predetermined price before the contract expires. Traders often use put positions in downward (or bearish) markets, aiming to profit by selling at a higher price than the asset’s declining value.

Key terms for trading cryptocurrency options 

Before you trade cryptocurrency options, it’s best practice to familiarize yourself with a few phrases associated with this type of trading. Learning the definitions of these terms will help you understand your rights and whether your position is profitable. 

• Strike price: The fixed price at which traders agree to buy or sell a digital asset. For example, a Bitcoin (BTC) call option with a $100,000 strike allows traders to buy Bitcoin at $100,000 during the contract's duration.  
• Expiration: The date when an options contract expires and is no longer active. Also referred to as the "expiry date," this sets the timeframe for the trade.
• Premium: The fee traders pay to purchase an options contract. Alternatively, traders who sell options receive the premium upfront but must fulfill the contract terms if the buyer exercises their rights.
• Intrinsic value: The positive difference between a cryptocurrency's market and strike prices. For example, if an Ethereum (ETH) call option has a strike of $3,500 and ETH trades at $3,600, the intrinsic value is $100. If this value is negative, it defaults to zero, as options cannot hold negative intrinsic value.
• Extrinsic value: The portion of an option's premium influenced by factors beyond intrinsic value, such as time until expiration, volatility, and market sentiment.
• In-the-money (ITM): An option is ITM when it's profitable. For call options, this occurs when the market price is above the strike price. For put options, it happens when the market price is below the strike price. 
• Out-of-the-money (OTM): An option is OTM when it's unprofitable. For call options, this means the market price is below the strike price, while for puts, it’s when the market price is above the strike.   

How to trade crypto options: A basic beginning strategy 

Trading cryptocurrency options can range from simple techniques like buying calls or puts to more advanced strategies involving multiple contracts. Here’s a step-by-step guide to getting started:

1. Choose a crypto options exchange

Find a reputable exchange that supports crypto options contracts, and be sure to compare features like fees, liquidity, and supported assets to select the best platform for your needs. 

Websites like CoinMarketCap list some of the best crypto options trading platforms under their derivatives tab. Popular centralized exchanges (CEXs) for options trading include Deribit, Binance, and OKX. That said, availability varies by region, and while global platforms dominate the crypto options market, access for traders in the United States is more limited due to regulatory restrictions. In the U.S., exchanges like the Chicago Mercantile Exchange (CME) offer regulated crypto options products, operating under the approval of the Commodity Futures Trading Commission (CFTC). However, many offshore platforms lack CFTC approval and are unavailable to U.S. users. If you're based in the U.S., it’s important to only use trading platforms that comply with CFTC regulations to ensure a legal and secure trading experience.

2. Set up and fund your account

Create an account on your chosen crypto options exchange and complete the setup process, which may include know-your-customer (KYC) identity verification. Add funds, whether fiat currency or cryptocurrency, and you’re ready to start trading.

3. Start with single-leg options

Beginners often start with basic single-leg options strategies, which involve buying a single call (if anticipating an asset's price increase) or a single put (if expecting a price drop). This straightforward method provides a foundation for understanding how options contracts work and how market movements impact their value.

4. Explore advanced strategies

Once comfortable, consider more complex strategies, such as:

• Writing options (or selling contracts instead of buying them) requires taking on the obligation to fulfill the contract terms.
• Multi-leg strategies (aka iron condor strategies) combine two call options and two put options at different strike prices. These strategies aim to profit from low volatility by defining a price range for the underlying asset, limiting potential risks and returns.

5. Manage your positions

If a trade doesn’t go as planned, consider “rolling” your position. Rolling involves closing the current options contract and opening a new one with a later expiration date to extend the trade’s potential. Essentially, it’s like "kicking the can down the road," allowing you to maintain your positions and wait for a more favorable price.

Benefits and risks of crypto options trading

Many traders like crypto options because they offer unique ways to navigate market trends and manage risk. However, like any trading tool, they come with both pros and cons to consider.

Pros of crypto options

• Portfolio protection without selling: Crypto options allow traders to hedge against downside risk without selling their long-term holdings. For example, puts can help traders profit during price drops, potentially lowering the cost per coin as traders wait for a market rebound.
• Capital efficiency: Options require less initial capital than buying cryptocurrency outright. Because they trade at premiums, traders can take sizable positions with smaller collateral. However, leveraging options can magnify both potential gains and losses, increasing the risk of losing the entire investment on a bad trade. 
• Defined risk exposure: Buyers know their maximum risk upfront, which is limited to the premium paid. Even in multi-leg strategies, traders can calculate their maximum loss from the beginning, ensuring they don’t risk more than they’re prepared to lose.

Cons of crypto options 

• Time-sensitivity: Every options contract has a set expiration. If the market doesn’t move as expected within this window, traders must take a loss or roll their position to extend the trade’s potential.
• Complex pricing factors: Unlike spot trading, options premiums are influenced by external variables like time decay, implied volatility, and market sentiment. These factors make predicting an option's price more complex than simply monitoring the underlying cryptocurrency’s value.
• Assignment risk for sellers: Sellers face the obligation to deliver or purchase the underlying cryptocurrency if the buyer exercises their option. This can be especially risky in volatile markets, as sellers may be forced into unfavorable trades at strike prices far from the market value.

Minimize crypto trading taxes with CoinTracker 

Confused about managing your crypto trading taxes? CoinTracker makes it easy. Simply create an account and link your exchange APIs and wallets. CoinTracker will organize your trading data into a user-friendly dashboard. In just a few steps, you can generate accurate, compliant tax forms to share with your CPA or sync seamlessly with tools like TurboTax and H&R Block.

Get started for free and discover how CoinTracker takes the stress out of crypto tax season.

Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.