As the economy tries to shift into high gear from a standing start, the world of cryptocurrency has moved onto the main stage. It has established itself as an asset class recognized by major asset managers, investment banks and hedge funds. As the speed of mainstream adoption continues to take the financial world by storm, it also paves the way for investors to explore a new frontier – crypto options.
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What are the 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 take directional bets on the price movement of an asset. Investors who expect the asset to appreciate can purchase call options which they will profit from if the market price of the asset exceeds the strike price. On the contrary, if they think that the asset is going to depreciate, they can buy put options, which will pay a profit when the market price of the asset drops below the strike price.
When these conditions are met, investors can choose to exercise their option, causing the issuer to buy or sell the underlying asset to or to the investor at the strike price. Or, they can just trade their options with others for a profit.
The truth about options
There are several characteristics inherent in options that make them more acceptable to investors, especially in a volatile market. With options, investors can gain exposure to larger positions at a fraction of the cost. For example, consider buying 100 shares for $ 50. To be in this position, an investor would need capital of $ 5,000. With options, however, the cost can be drastically reduced. The same investor can get the same exposure to a stock or cryptocurrency by purchasing an option for a fraction of the cost, say with a premium of $ 150.
Options are a powerful tool for empowering investors to capitalize on market volatility and enable them to participate in markets while freeing up capital, allowing them to diversify their strategy and take more positions.
Options also allow investors to gain exposure to market volatility. Since the price of an option is directly correlated with market volatility, options tend to become more expensive in a volatile market. Thus, an investor holding a long position in an options contract also has everything to gain from market volatility.
The most important use case for options, however, is their use as risk management products. Investors can buy puts (or bet against the market) to hedge their portfolio when they are unsure of the market going up. It’s like buying insurance on your portfolio to protect it from market volatility or downward movements.
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Institutional frenzy for options and crypto
As institutional interest continues to grow in cryptocurrency markets, so does institutional appetite for crypto options. Strategic investors have taken refuge in the idea that options allow them to capitalize on the volatility of crypto markets to capture high profits while keeping them away from higher risk investments. The volatile nature of the crypto markets creates an urgent need for investors to be able to diversify their strategies and hedge their positions while being exposed to the upside.
The options markets have given investors the opportunity to play on the ground, invest strategically and study the market. Even during what some are calling a bear market, this has kept activity at a high level.
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Money doesn’t stop at institutions
The power that options offer to individuals is also being realized by a growing number of retail investors, even in the midst of global economic uncertainty. According to Trade Alert, 2020 has been a banner year for the options market in terms of volume traded, with 7.47 billion contracts traded. This trend continued with conviction until early 2021.
Surprisingly, most of the increase in volume came from retail investors. An article from Barron’s pointed out that options brokers such as Schwab saw a 116% increase in options traded. It is estimated that 60% of all options traded are from retail investors, as evidenced by the position size of less than 10 contracts. In fact, the number of single contract transactions has doubled over the same period.
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As we move forward into 2021, big names such as Goldman Sachs have also announced that they are expanding their crypto presence by offering trading options on Ether (ETH) after seeing huge institutional demand. These products will also apply to their retail customers and will certainly reduce some of the leverage of the system, creating an easy ramp for investors.
Today, centralized exchanges are better equipped to handle the demand for retail options. They don’t suffer from the network congestion encountered on Ethereum, which leads to instant transaction execution with lower fees.
This does not exclude the innovations that accompany the accelerated pace of decentralized finance. DeFi has disrupted many traditional financial industries and seeks to make options more readily available. Decentralized exchanges will play a key role, going forward, in connecting retail investors to options as its ecosystem continues to evolve.
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With the economic impact of the global pandemic expected to last until 2025, cryptocurrency markets will undoubtedly remain volatile. DeFi apps 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 contain any investment advice or recommendations. Every investment and trading move involves risk, and readers should do their own research before making a decision.
The views, thoughts and opinions expressed here are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.