Must-Know! Five Derivatives Terminologies
Crypto futures are contract-based derivative instruments that derive their value from an underlying asset. In essence, crypto futures are agreements between two parties to acquire or sell a cryptocurrency on a particular date and at a predetermined price. In the case of crypto futures, the agreement often tracks an underlying asset, which in this case would be a digital token.
In their most basic form, crypto futures can be thought of as a bet that allows traders to bet on the future price of an asset. Traders might go long or short depending on whether they anticipate a rise or a drop in price activity. Traders that choose to go long will often agree to buy the asset on a specific day, while short-sellers will agree to sell the asset on the same date. The parties will settle when the contract's expiration date approaches, and the contract will terminate as a result.
Bitcoin Futures
Bitcoin futures are the most popular type of crypto futures trading which enables investors to gain exposure to Bitcoin without owning the underlying cryptocurrency. Similar to commodities and stock index futures, Bitcoin futures essentially allows investors to speculate on the price of Bitcoin in the future.
Simply explained, a Bitcoin future is a contract or agreement between two parties to buy and sell Bitcoin at a predetermined price at a future date. Neither party is required to hold the underlying asset, which will be Bitcoin in this scenario. Instead, they just settle the deal in US dollars or any other currency that has been agreed upon.
One of the biggest advantages of Bitcoin futures is that it helps to inject additional liquidity into the market, and thereby provides more opportunities for arbitrage. Typically, the value of different Bitcoin futures contracts would vary depending on the value of Bitcoin.
Basics of Bitcoin Futures Trading
Essentially, a trader who buys or sells a Bitcoin futures contract is attempting to forecast the price of Bitcoin in the future. This means that the trader must guess whether the contract will expire above or below the "strike price" - the price at which the market expects the asset to trade when the contracts expire. Typically, most Bitcoin futures contracts will have a duration of at least 3 months, although both shorter and longer durations are possible.
Let us now look at an example. Assume that Bitcoin's current price is $30,000. A three-month Bitcoin futures contract with a strike price of $31,000 is what you're looking at. You believe Bitcoin will be worth more than $31,000 in three months, so you decide to go ‘long'. Assume each futures contract is worth $500, and you purchase a total of five contracts. Bitcoin will be worth $33,000 when the futures expire. This is $2,000 more than the $31,000 strike price. Because you had five contracts in all, your total profit will be $10,000.
Crypto Options
Crypto options are a type of derivative contract that gives the buyer the right, but not the obligation, to buy or sell a specific asset at a specific price and date. A "call" option is one that allows you to buy the underlying asset, whereas a "put" option allows you to sell it.
Options work in the same way that other derivatives do. It allows traders to speculate on the future price of an underlying asset and, like futures contracts, can be settled in cash (US dollars) or actual cryptocurrencies. Unlike purchasing cryptocurrencies on an exchange, options allow traders to speculate on the future direction of a market price - both up and down.
Bitcoin Options
Bitcoin options, as previously mentioned, offer traders the right, but not the obligation, to buy or sell Bitcoin at a specified price – known as the striking price – on specific expiry date. Traders will have to pay a premium to purchase an option, which is normally less expensive than purchasing cryptocurrencies outright.
Traders can select from a variety of bitcoin options strategies depending on their trading purpose - whether it's to speculate on bitcoin's price or to hedge an existing BTC holding from risk. A straddle options strategy is one that includes simultaneously purchasing and selling an equal number of Bitcoin puts and calls with the same strike price and expiration date, and this is a great strategy for speculative traders. A covered call, which includes writing a call option for the same number of BTC that you already possess, is another classic options strategy for hedging an existing holding.
If the market price has dropped, the short call option will let you recover some of your BTC losses. If the market price rises, the trader will most likely have to sell his or her position, but they will have earned the option premium.
Basics of Bitcoin Options Trading
Let's imagine the current price of Bitcoin is $30,200, and the strike price is $31,000. If you purchase one option contract and Bitcoin ends at $32,000, you will have made $1,000. Your profit would have been $10,000 if you had ten contracts.
Here's an example of a Bitcoin options trade in its most basic form. Let's say you're looking for a 3-month Bitcoin options contract. The strike price of the options is $28,000. Let's say each contract's premium is $750. Your total premium will be $1,500 because you purchased two option contracts. Assume that Bitcoin is worth $30,500 when the options expire. This is $2,500 more than the $28,000 strike price. However, even if you made a profit of $2,500 per contract, you must deduct the $750 premium. This results in a $1,750 net profit per contract. The total profit, therefore, would be $3,500 because you bought two contracts.
Perpetual Contracts
A perpetual contract is similar to a futures contract in that it allows a person to buy or sell an asset at a fixed price at a predetermined date. Although perpetual contracts are derivative contracts that are similar to futures, they do not have an expiration date or a settlement date, thereby allowing them to be held or traded indefinitely.
Perpetual contracts have recently gained popularity over crypto futures because they allow traders to retain leveraged positions without having to worry about an expiration date. C-Trade offers up to 150x leverage on perpetual contract crypto trading, enabling traders to multiply the impact of their capital. Perpetual contracts, unlike futures, resemble a margin-based spot market and trade close to the underlying asset's index price. Perpetual funding rates - the fundamental method that ensures price stability for perpetual contracts - make this possible.
Spot Trading
Spot trading is one of the most basic types of investment an investor can make, and it is also the most popular one. Specific to the crypto market, spot trading means that you purchase a cryptocurrency such as Bitcoin, and then hold it until its value increases or use it to buy other altcoins that are likely to increase in value.
Typically, in a spot market, the financial instruments will be traded for immediate delivery. Given how trades are immediately swapped for the asset, spot markets are also sometimes referred to as "physical market" or "cash markets". A spot price refers to the current price of a financial instrument or the price at which an instrument can be bought or sold immediately.
Derivatives Trading
Unlike spot trading, in derivatives trading, the investor does not have to actually own the underlying asset. Instead, they typically enter into a contract/agreement to buy a cryptocurrency such as Bitcoin at a pre-established time and price in the future. Whether the investor makes a profit or a loss would depend on the price action of the underlying asset. In fact, derivatives are created in the form of contracts that allow you to speculate the price of a cryptocurrency without having to own it, therefore the contract will be cheaper than the asset price.
The biggest benefit of derivatives trading is that it provides the highest liquidity compared to any other crypto market in the world. They also make selling short a much easier process and are therefore beneficial for active traders. And of course, traders do not have to physically own a particular amount of crypto in their crypto wallets to be eligible for trading in a derivatives market.
Disclaimer: The content in this article comprises personal opinions and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. C-Trade, its affiliates, agents, directors, officers, or employees do not guarantee the accuracy, validity, timeliness or completeness, of any information or data made available and assume no liability as to any loss arising from any investment based on the same.