Options. If I want to understand what options are, I think the first step is to know what futures are. Futures are a certain commodity for some point in the future—such as cotton three months from now, or gold five months from now. Correspondingly, there is spot (cash) trading—for example, gold right now, or cotton right now. The price of spot is simply the price of a certain commodity at the present time, while the futures price is the market’s pricing of a commodity (gold, oil, etc.) for some time in the future. This futures price is determined by futures trading. Futures trading is essentially the result of a contest between buyers and sellers (longs and shorts) whose different predictions about the future price compete with each other. If the longs are stronger—if they have more power and stronger funding—then more buy positions appear in the market, and after the long and short orders are matched in futures trading, the futures price will rise. Conversely, if the shorts are stronger and have more power and funding, then more sell positions appear in the market, and the futures price will fall. Futures trading was originally mostly used for hedging—such as warehousing, delivery, and settlement. However, because it inherently includes the attribute of predicting future prices, and because in real-world commodity businesses there is limited cash flow and it is convenient for more people to participate, futures also take on a leveraged feature. As a result, many people, when they talk about futures, end up thinking about speculative trading.

All futures trading ultimately has a delivery date—meaning the earlier buying and selling are done for delivery on that delivery date. One note: delivery is only available through qualified storage warehouses and certain companies; retail investors don’t have access to real delivery. Most rules require that positions must be closed within one month prior to delivery. Delivery is a real, consummated transaction. For example, in the futures market for cotton storage, a warehouse owner might sell 10,000 lots of short positions and keep them open until the delivery date without closing. Then, on the delivery date, he truly has to sell the 10,000 lots of cotton he holds. Likewise, if someone holds 10,000 lots of long positions and keeps them open on the delivery date, they truly have to buy 10,000 lots of cotton at their long position’s final average execution price. For instance, suppose it’s September now and the cotton spot price is 100 USD. A few days later it rises to 300 USD, and the market’s pricing for cotton three months from now (i.e., the December delivery) remains high. Then you can sell short positions in the market early to lock in profits. Even if three months later (December) the cotton price falls back to 100 USD, my short position still earns a lot of money—essentially selling cotton at the September price in real terms. If you’re not a company or you don’t have the relevant qualified warehouse, but you’re an individual trader who predicts that cotton will fall three months later, then you can short the cotton contract for December and close at an appropriate price to capture the corresponding profit.

An option means using a certain premium to buy the right to settle the corresponding futures at a specific price in the future. For example, suppose the current September cotton price is 100 USD. I predict that three months from now the cotton price will reach 200 USD, but I only have 30 USD. I’m not willing to use just 30 USD to buy cotton at 100 USD now and then sell it at 200 USD to earn 30 USD profit. Instead, I can buy a three-month call option with a strike price of 150 USD. If three months later the cotton price rises to 200 USD, then for each option contract I can earn 50 USD. According to the option pricing formula and market expectations, at this point a three-month 150 USD strike cotton call option costs only 10 USD per contract. So with 30 USD, I can buy 3 contracts. Then by buying and selling, I can earn 150 USD. The same logic applies to put options as well.

So how is the price of an option determined? First, the basis for current option pricing is determined by the Black-Scholes formula. If you’re interested, you can look up how this formula works. However, the value calculated by this formula is only a theoretical price. In reality, the market traded price will fluctuate around it. When the market is overheated and emotions are extreme, the deviation can be larger. In other words, the option’s market price is essentially the theoretical price calculated by the model plus the effect of market sentiment.

So what determines these theoretical option prices? Roughly, there are four main factors.

The first is the current spot price. The cheaper the spot price, the cheaper the option price (for both calls and puts). In other words, the spot price and the option price are directly proportional.

The second is the strike price—the matched price at some future level. For example, for cotton with a spot price of 100 USD, under the same delivery time, a 150 USD call option is almost always cheaper than a 120 USD call option. And as the gap between the spot price and the strike price increases, the option price drops quickly.

The third is the time to which the option corresponds. A 150 USD call option 200 days from now, a 150 USD call option 100 days from now, and a 150 USD call option 10 days from now—all these option prices decrease gradually as the option’s time horizon shortens.

The fourth factor is volatility. You can understand it as how much the market price fluctuates. The higher the volatility, the more expensive the option; conversely, the cheaper it is. If the market price is as still as a dead pond for a month and fluctuates only around 1%, then option prices will be very cheap. But if the market price moves up and down by 10% every day, then option prices will become very expensive.

So what’s different about options on virtual currencies—like Ethereum and Bitcoin? Actually, after the explanations I gave above, there isn’t anything too different. The main difference is that perpetual contracts have no delivery date—so they’re futures that can be traded continuously without any physical delivery. And the object of the options trading changes from a traditional asset to a virtual currency, not a specific real-world item.

That’s basically how options work. If we go into more detail, we can further divide them into in-the-money options and out-of-the-money options, as well as long-dated options and near-expiry options. But these are specific definitions within the concepts I mentioned above, and they don’t affect everyone’s overall understanding of options. If you’re interested, I’ll make a follow-up episode about how to trade options, where I’ll introduce my views on options in more detail.#期权交易 #期货市场