What are Bitcoin Futures, Options and CFD’s?

Tuesday, 10 May 2016 17:03

Bitcoin options graphicFirst of all what are options and what are futures – to do a long explanation can get quite complicated so be prepared.

The idea was to provide farmers and producers to lock in their profits and not be subject to volatility in prices when they were ready to sell what they had made – a way of transferring risk or taking on risk.

The futures contract is a way of agreeing to sell or buy a specific quantity of a specific product at a specific price on a future date.

The buyer of the futures contract buys the right to sell at the price and the seller agrees to accept the goods at that future date for that price – the buyer is said to go short and the seller is said to go long as if the price for the product goes up he has the right to buy at a lower price – vice versa for the seller as he can sell the product for a better price if the price goes down. Futures can be traded during their contract life and have value depending on the perceived price when the contract will end – and as the price moves generally the losing party has to post money in escrow as collateral to reduce counterparty risk.

With Bitcoin futures you are fixing the price that you want to sell or buy a certain amount of bitcoins at a certain point in the future. As you don’t have to make the purchase immediately then you are also leveraging your position by having exposure to an asset whilst only posting collateral – or a small percentage of its cost – so with 10 to 1 leverage you are exposed to ten Bitcoins instead of one – but also exposed to their potential losses – leverage is a dangerous game but also a potentially rewarding one.

With options there is a more complex set of instruments and terms – there are calls and puts with calls and puts both having a long and short position. If you buy a call you are said to go long and if you sell a call you are said to go short – and for put options you are said to go long if you buy a put option and short if you sell one.

A Bitcoin call option gives exposure to rising prices in the underlying above a certain price – known as the strike price – the long call will gain money if the price of bitcoin rises to be paid by the short position in the Bitcoin call. If the Bitcoin price is at $300 and the strike price is set to above, at, or below that, then the long Bitcoin call option is said to be in the money, at the money, or out of the money. The seller (short) position in the Bitcoin call position will receive a fee from the long position at the start of the contract. Contracts can be exercised in various ways – for example some options can be settled during the contracts existence (European options) or only at its end (American Options).

For Bitcoin Puts the pricing idea is very much the same except the bet is only if the price goes down below a certain strike price. For example long put option would gain money if the Bitcoin price fell below the strike price of the option – so if the strike price was $350 per Bitcoin and the Bitcoin price was at $300 then the option would be in the money and priced at $50 or more depending on how much time value the Bitcoin option contract had left. The short put Bitcoin position would be losing money as they would have sold the option on the bet that the price would rise and so owe money as it has fallen.

CFD’s are slightly easier for the smaller investors to gain leverage at through the range of platforms such as Plus500, Avatrade and Etoro. However most forms of contracts can be structured i.e. futures and options – if a stop loss is put into a CFD contract it essentially converts it from a future like instrument to option contract. CFD’s allow for smaller amounts and more custom sizes than larger exchanges and hedge fund sized positions. CFD providers provide a variety of potential instruments and methods to gain exposure and leverage to the Bitcoin price as well as the Litecoin price - and some innovative crypto or bitcoin exchanges are structuring options and futures contracts for Bitcoin and Litecoin and other crypto currencies.

These contracts are extremely useful for various hedging techniques and can be used by various exchanges who hold a lot of Bitcoin or cash – so they can pay a premium to rid themselves of the volatility risk – i.e a Bitcoin exchange or ATM provider could buy a long Bitcoin Put that matches the value of its holdings.

This Bitcoin Put would gain money if the price of Bitcoin went down but would cost them money to have that protection. They are paying money to reduce the volatility risk of Bitcoin. If the price goes up, they have spent the money on the option but, their holding are exposed to the rising Bitcoin price by the Bitcoin they hold – of course, whether this is worth it depends on the cost of hedging their position to downside risk!

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