May 20, 2021
Dopex Essentials: What Are Options?Dopex-Essentials
Options trading in the DeFi space is a facet of the market that is relatively underpopulated. This can be largely attributed to the fact that not many people understand exactly what options are and how options trading works.
We want our users to enter the world of options with a good understanding of what exactly they are doing. The Dopex Essentials Series will guide you through everything you need to know to begin trading options on Dopex. Ensuring that you get the most value out of our platform.
Without further ado, let’s take a deep dive into options.
So, what exactly are options?
There are two types of options — call options and put options.
A call option is the right to buy the underlying asset at the strike price on the expiry date. The buyer of a call option is betting on the price of the asset going up.
A put option is the right to sell the underlying asset at the strike price on the expiry date. The buyer of a put option is betting on the price of the asset going down.
Specifications Of An Options Contract:
Underlying asset — The underlying asset, the price of which is being speculated on, for example, Bitcoin.
Expiry date — The date the option will expire and be exercised, after this date, the contract is no longer valid.
Strike price — The price at which the buyer has the right to buy or sell the underlying asset at expiry.
Option type — Call or put
Option price (premium) — The price the buyer pays to the seller for the right to buy or sell the asset at the strike price on the expiry date.
All options on Dopex are European style, which means they can only be exercised at expiry, unlike American style options that can be exercised any time until expiry.
You may be an option buyer because:
- You want to limit your risk while still having large profit potential
- You want to take a position that cannot be stop hunted or liquidated
- You are predicting a large price movement or an increase in implied volatility
You may be an option seller because:
- You want to collect the premium for the option
- Time decay works in your favor, if there is no price movement, you will make a profit
- You are predicting small price movements or a decrease in implied volatility
- You can profit from the market’s tendency to overestimate future volatility
Here is how options trading works:
An options seller “writes” (creates) “call” and “put” options contracts. Each contract has an expiration date and a strike price.
The options seller then lists the contracts on a crypto options exchange. Sometimes, the buyer of an option can also place an order on the exchange and an options seller can sell into it.
The cost of an option is usually referred to as a “premium.” The price of premiums is relative to the time remaining on the contract, implied volatility, interest rates, and the current price of the underlying asset.
Remember these terms:
In the money (ITM):
- For a call — this term is used when the strike price is lower than the current price of the underlying asset.
- For a put — this term is used when the strike is higher than the current price.
At the money (ATM):
- For both a call and a put — this term is used when the strike is equal to the current price.
Out of the money (OTM):
- For a call — this term is used when the strike price is higher than the current price of the underlying asset.
- For a put — this term is used when the strike is lower than the current price.
A trader wanting to buy a call option with a strike price that is lower than the current market value of the underlying asset will have to pay a significantly higher price for the contract.
This is because the contract is “in the money” and already has intrinsic value. Of course, that doesn’t mean the price will continue to stay above the strike price before the contract expires.
Let’s take a look at an example:
The price of one bitcoin at the start of June is $54,000 but Mario thinks by the end of July the price will be much higher. He decides to buy 10 options at a strike price of $54,000 for a 0.003 bitcoin premium per contract, which expires on July 30th.
0.003 bitcoin at $54,000 = $162 at the time Mario purchases the call options. 10 x 162 = $1,620.
Each contract gives Mario the right to purchase 0.1 of a bitcoin at the price of $54,000 per coin. This means Mario can buy one bitcoin at $54,000 when the contract expires at the end of July. (10 x 0.1=1)
Scenario X: Upon expiry, bitcoin’s price is $60,000. Mario exercises his call option and makes a $6,000 profit (60,000–54,000=6,000). Minus his premium, Mario walks away with $4,380 (6,000–1,620=4,380)
Scenario Y: Upon expiry, bitcoin’s price is $40,000. Mario decides not to exercise his call option because it’s “out of the money.” All in all, Mario makes a loss of $1,620, the price he paid for the call premium.
Crypto Options vs Traditional Options
The main difference between trading traditional options vs crypto options is that the crypto market is live 24/7. Crypto markets are also typically more volatile, meaning the price tends to rise and fall more frequently and sharply.
The benefit of this high volatility is that traders stand to potentially make better returns if the market goes the way they predict because there will be a greater difference between the strike price and the settlement price at expiry.
Dopex is a decentralized options protocol that aims to maximize liquidity, minimize losses for option writers and maximize gains for option buyers — all in a passive manner.
Dopex uses option pools to allow anyone to earn a yield passively. Offering value to both option sellers and buyers by ensuring fair and optimized option prices across all strike prices and expiries. This is thanks to our own innovative and state-of-the-art option pricing model that replicates volatility smiles.
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