Despite ongoing vaccination efforts and pandemic aid, the global economy is looking remarkably different than it was over a year ago. The new financial landscape and ongoing uncertainty have accelerated the move away from traditional financial institutions.
As the economy tries to get into full swing from scratch, the cryptocurrency world is at the main stage. It has established itself as a recognized asset class with major asset managers, investment banks and hedge funds. As the speed of mainstream adoption continues to take the financial world by storm, it is also paving the way for investors to explore a new frontier – crypto options.
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What are options?
Options are financial contracts that allow investors to buy or sell the underlying asset at a specified price at a future date. This allows investors to place directional bets on the price movement of an asset. Investors who expect an increase in the value of the asset can buy call options, which they benefit from if the market price of the asset exceeds the strike price. Conversely, if they believe the asset is depreciating in value, they can buy put options that generate a profit if the asset’s market price falls below the strike price.
If these conditions are met, investors can exercise their option and request that the issuer buy or sell the underlying asset from or to the investor at the exercise price. Or they can just trade their options on others for a profit.
Truth about options
Options have several properties that make them more palatable to investors, especially in a volatile market. Options allow investors to take larger positions at a fraction of the cost. For example, consider buying 100 shares of a share for $ 50. To be in this position, an investor would need to have $ 5,000 in capital. However, options can significantly reduce costs. The same investor can get the same exposure to a stock or cryptocurrency by buying an option at a fraction of the cost, such as a $ 150 premium.
Options are a powerful tool for allowing investors to take advantage of the volatility of the markets and allow investors to participate in the markets while freeing up capital, thereby diversifying their strategy and taking a larger number of positions.
Options also allow investors to be dependent on market volatility. Because the price of an option is directly related to market volatility, options tend to be more expensive in a volatile market. Thus, an investor who is long in an options contract can also benefit from market volatility.
However, the biggest use case for options is their use as risk management products. Investors can buy put options (or bet against the market) to hedge their portfolio when they are unsure of how the market will perform. This is like buying insurance for your portfolio to protect it from market volatility or downward movements.
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Institutional frenzy for options and crypto
As institutional interest in the cryptocurrency markets continues to grow, so does the institutional appetite for crypto options. Strategic investors have taken refuge in the idea that options allow them to capitalize on the volatility of the crypto markets to generate high profits while keeping them away from riskier investments. The volatility of the crypto markets makes it imperative for investors to diversify their strategies and hedge their positions while still pointing up.
Options markets have given investors the opportunity to play on the field, invest strategically, and study the market. Even during what has been called a bear market, this has kept activity high.
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Money doesn’t stop at institutions
The power that options offer individuals is being recognized by increasing numbers of private investors, even amid global economic uncertainty. According to Trade Alert, 2020 was a record year for the options market in terms of volume traded with 7.47 billion contracts traded. This trend continued with conviction until the beginning of 2021.
Surprisingly, most of the volume increase was contributed by private investors. A Barron’s article highlighted that options brokers like Schwab saw options traded up 116%. It is estimated that 60% of all options traded come from retail investors, as evidenced by the position size of fewer than 10 contracts. In fact, the number of single contract trades has doubled over the same period.
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Throughout 2021, big names like Goldman Sachs also announced that they were expanding their crypto footprint by offering options trading in Ether (ETH) after seeing huge institutional demand. These products also apply to their retail clients and will certainly reduce some of the leverage in the system, making it easy for investors to get started.
These days, centralized exchanges are better equipped to service retail demand for options. You don’t suffer from network congestion on Ethereum, resulting in instant execution of trades with lower fees.
That doesn’t rule out the innovations that come with the accelerated rate of decentralized funding. DeFi has turned many traditional finance industries upside down, trying to make options more readily available. Decentralized exchanges will play a key role going forward in connecting retail investors to options as the ecosystem continues to evolve.
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With the economic impact of the global pandemic expected to last through 2025, cryptocurrency markets will no doubt remain volatile. DeFi applications and centralized exchanges are working diligently to bring more and more cryptocurrencies to the options market and are evolving to simplify complicated trading strategies for investors.
This article does not provide investment advice or recommendations. Every step of investing and trading involves risk, and readers should do their own research when making a decision.
The views, thoughts, and opinions expressed herein are solely those of the author and do not necessarily reflect the views and opinions of Cointelegraph.
Pankaj Balani has over eight years of corporate leadership and derivatives trader experience, and has devoted the last two years to building Delta Exchange, a next-generation derivatives exchange where traditional financial instruments and cryptocurrency trading overlap. As a UBS alumni, Balani gained experience in finance, derivatives and quantitative finance through his positions at Edelweiss Asset Management and Elara Capital. He holds a degree in engineering physics from the Indian Institute of Technology in Delhi and an MBA from the Indian School of Business.