Bitcoin’s New Shorts

On Friday, 5/28, skew.com tweeted:

“55k #bitcoin options expiring this Friday with $40k strike open.”

Perhaps you feel like you’ve just landed into a steaming hot bowl of alphabet soup. You are wondering, what the heck is an option or a strike, what are these numbers, and is this bad for the Bitcoin market? I’m glad you asked, we’re going to talk about that.

What is an Option?

Options are more easily understood when contrasted by, futures. When you buy futures, presumably based on some thinking about the future, you agree to take action in the future. I.E., buying a Bitcoin if conditions are met. In the options, you, again presumably based on something about the future, buy an option to buy or sell Bitcoin in the future.

We’re looking at options here, because we they’re Bitcoin’s new shorte. So with those, to understand how they work — we look at the Strike Price, Spot Price, Time to Maturity, and Implied Volatility.

Let’s look at each of these individually:

Strike Price(k):

This is the price that you agree you will buy or sell at, in the future. If the opportunity “strikes,” you can take your action, purchase, or sell.

Spot Price(s):

This is the price in today’s value, right now as you’re making the analysis or when you’re making your option agreement.

Time to Maturity:

This is how long the option period is, I.E.; I’m buying to option to buy that will mature in 3, 6, or 9 months.

Implied Volatility:

This is a measure of how much risk is in the market. While some voodoo is involved here, it’s a commonly agreed-upon voodoo, so there is a common language among options traders. If the gap between options buyers and sellers is vast, this would indicate that there is an anticipation of wide swings (higher implied volatility). Market sentiment drives prices, and price differences drive implied volatility.

The difference between the Strike Price (k) and the Spot Price is our premium (s) is (s-k) = premium. Or the price you agree to minus the price you bought it at leaves you with your potential for return. For example, I buy a bitcoin option with a spot price (today’s value) of $34,000 with a strike of $40,000 I stand to earn a premium of $6,000. Easy peasy, bring on the money!

Finally, traders talk about a spot being in, out, or at the money. This is more crazy talk to make you feel outside their club. Here is what it all means.

In the money, out of the money, at the money, and more!

Options traders live and die on their ability to keep you confused. The relationship between the spot and strike price is the “moniness” of an option, described by the three terms above. Let’s push through the trader’s confusion and describe each of these three below.

Before we jump in, there is one high-level topic we have to cover, calls and puts. These are the types of options in scope for us. A call option is one you purchase when you want to buy a bitcoin, and put is the right the sell one.

In the money

This is a valuable option because the spot price, now, is higher than the strike price. Your strike price is lower than the current price, so the seller would have to give it to you higher than the current value. If you exercised the option, you would sell it and make money, so you’re “in the money”.

Out of the money:

This is NOT in the money. An Out of the money call option has a strike price higher than the current market price of Bitcoin. The flip side is of a put option with a strike price less than market price of Bitcoin.

Why would I use options:

You like gambling!

The ability to gain upside from Bitcoin and be “in the money”. For more advanced traders these techniques allow a portfolio holder to hedge their risk with several advanced approaches and mixes of puts calls, options, futures long and short, etc.

If you like to gamble, I mean, someone found you slumped over in an alley once because you’d been on an all-night bender and lost everything, stay tuned!

Futures trading with leverage

If you think, for example, Bitcoin will drop, you want to bet on Bitcoin’s drop, you can leverage a future position. SO, let’s say, for example, you think it won’t hit 40k strike price by May 28th, you have put a future short against Bitcoin. You’re gambling about the future of the Bitcoin market.

Leverage percentages vary from bookmaker to bookmaker. You have limit and market orders to pick from, meaning you’re limiting what you’ll buy or sell at or buying and selling at the market’s current value (whatever that is). You have stop limits, and these let you set a circuit breaker in front of the liquidation mark to pull out before you lose everything.

All that said, go back to the original Tweet: “55k #bitcoin options expiring this Friday with $40k strike open.” today, options expire at a 40k, strike. Now you know what is happening; it’s Bitcoin’s new short(s). How all this shorting and longing drives other investor behaviors who want to see Bitcoin hit or not hit $40k is hard to say.

Be sure of this, the shorts and longs puts and calls do impact market gravity — these are Bitcoin’s new shorts!