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What Is Options Trading

Binance
2022-09-08 09:01

What are Options?

Options are financial derivatives that give holders the right, but not the obligation, to buy or sell an underlying asset at a predetermined price and date. There are two types of options: Call and Put Options.
Purchasing a Call Option gives the holder the right, but not the obligation, to buy the underlying asset at an agreed-upon date and time.
Meanwhile, a Put Option gives the holder the right, but not the obligation, to sell the underlying asset at an agreed-upon date and time.
Traders typically enter into a Call Option when they anticipate an increase in the underlying asset’s price and a Put Option when they expect the underlying price to decline.

What is an Option Symbol?

The symbol of an option contract consists of the Underlying Asset, Expiry Date, Strike Price, and Option Type. It is listed in this format: Underlying Asset-YYMMDD- Strike Price-Option Type.
For example, the “ETH-221230-2000-C” symbol refers to an Ethereum Call Option with a Strike Price of 2,000 USDT and an expiration date on 2022-12-30.

What is the Strike Price?

When a derivative contract is exercised, the underlying crypto asset can be bought or sold at a predetermined price known as the "Strike Price."
For Call Options, the Strike Price is the price at which the buyer of the option contract can buy the underlying crypto asset. For Put Options, the Strike Price is the price at which the underlying crypto asset can be sold.

What is the Settlement Price?

Settlement Price is the arithmetic mean of the Spot Price Index during the 0.5 hour preceding the expiration time as indexed by the platform.
Example:
ETH-211230-2000-C contract settles at 2021-12-30 08:00:00. The settlement price will be the average price of the ETH Spot Index price from 2021-12-30 07:30:00 to 2021-12-30 08:00:00.
Settlement Price = 1/1,800 * (Price_t1 + Price_t2 + ...... + Price_t1,800)

What is the Expiration Date?

The expiration date is the last date on which the buyer of the option can exercise it according to its terms.

What is the Option Premium?

The Premium is the trading price of an option contract. It is the amount paid by an investor to obtain the right, but not the obligation, to exercise an option contract.
Option buyers acquire this right from option writers (sellers) at a value called the Premium.
The Premium value will change in accordance with market conditions, such as a change in the underlying asset's price or volatility, and/or a change in the time to expiration or interest rates.
The nearer the Strike Price of the option is to the underlying asset price, the more expensive the Option Premium will be.

Options Limit Order Types

Currently, Binance only provides the following limit orders for Options traders:
  1. Limit
  2. Best Bid Offer (BBO)
As the name suggests, Limit is basically a standard limit order. You can set your target Limit Buy or Limit Sell prices. A Limit Order will only be executed once it matches the corresponding offer/bid price on the order book. Please note that all orders placed on the order book are on a first-come, first-served basis.
Best Bid Offer (BBO) is another form of Limit Order. It automatically places your Limit Buy Order at the current Best Offer price or your Limit Sell Order at the current Best Bid price. Unlike a Market Order, BBO does not guarantee order execution. BBO only helps you place limit orders at the current best bid/offer price.

Daily Options (American Options) vs. European Options

Different time frames and exercise mechanics
Daily Options are American-style options that allow you to exercise the options contract any time before the expiration date, while European-style options can only be exercised on the expiration date.
Similar to European Options, Daily Options are cash-settled. Therefore, the physical delivery of the underlying asset is not required.
Unlike European Options, Daily Options (American) offers a shorter expiration time frame, ranging from 5 minutes to 1 day. Daily Options (American) has only one Strike Price, which is equivalent to the current contract price of the underlying Spot Price Index. In other words, Daily Options (American) are always "at-the-money".
Trading Daily Options on Binance
You can only be a buyer of Daily Options (American) as Binance is the sole issuer (option seller). Therefore, there is no order book for Daily Options (American). As an option buyer, the maximum loss for an option contract is the Premium you paid. In this case, your breakeven point is the Strike Price +/- the Premium (depending on whether it is a Call or a Put contract).
Two different styles of options support different trading strategies
For instance, American Call Options owners may wish to exit their trading positions before the expiration date by exercising the options if the current market prices are in their favor.
They can otherwise choose to hold their position until the contract expires if they believe the market will continue to move in their favor.
European Options owners can also exit their positions before the expiration date by selling their options back onto the market.

What are the advantages of trading Options?

  • Downside is capped at the Options Premium paid
  • Hedge against market risks
  • More flexibility in managing portfolio risks
  • You can set up multiple trading strategies with unique risk/reward profiles
  • Potential to profit from a variety of market conditions, such as the bull, the bear, and the sideway market trends.
  • Traders only have to pay the required Options Premium to get the same exposure as holding an equivalent Futures or Spot position. As such, Options are a great way to amplify trading results due to the lower capital requirements

How does a Call Option work?

A Call Option is a contract between two parties whereby the buyer has the right, but not the obligation, to buy an agreed-upon quantity of the underlying asset from the seller at a predetermined time (expiration date) for a pre-specified price (strike price). The buyer pays the seller a Premium for this right, which is the option's price.
The following graph illustrates the payoff diagram for Binance Call Options buyers:
Example of a Call Option:
Suppose you purchased a 1 ETH Call Option, with an expiration date on April 1, a Strike Price of 2,000 USDT, at a Premium (the option price) of 10 USDT. This means you have the right, but not the obligation, to buy 1 ETH for 2,000 USDT on April 1.
ETH price reaches 2,020 USDT on April 1, and you decide to exercise your Call Option contract. You can buy 1 ETH from the Call Option seller by paying the Strike Price of 2,000 USDT and sell it at the Spot Index price in the market for 2,020 USDT. Settlements are automatically completed by Binance upon your confirmation.
Given that the ETH settlement price on April 1 is 2,020 USDT.
On the Settlement date, your net profit would be:
Payoff = 2,020 USDT (Settlement Price) - 2,000 USDT (Strike Price) = 20 USDT
Exercise Fee = Minimum [Exercise Fee Rate * Settlement Price * Contract Unit, 10% * Option Value] * Position Size = Minimum [0.015% * 2020, 10% * 20] = 0.303 USDT
Net Profit = 20 USDT (Payoff) - 10 USDT (Premium) - 0.303 USDT (Exercise Fee) = 9.697 USDT
In general, the payoff to a Call Option buyer upon exercise is: MAX (Settlement Price - Strike Price, 0)

How does a Put Option work?

A Put Option is a contract between two parties whereby the buyer has the right, but not the obligation, to sell an agreed-upon quantity of the underlying asset to the seller at a predetermined time (expiration date) for a pre-specified price (Strike Price). The buyer pays the seller a Premium for this right, which is the option's price.
The following graph illustrates the payoff diagram for Binance’s Put Options buyers:
Example of a Put Option:
Suppose you purchase a Put Option of 1 ETH, with an expiration date of April 1, and a Strike Price of 2,000 USDT for a Premium (the option price) of 10 USDT. This means you have the right, but not the obligation, to sell 1 ETH for 2,000 USDT on April 1.
ETH price drops to 1,980 USDT on April 1, and you decide to exercise your Put Option contract. You can buy the underlying ETH asset at the Spot Index price of 1,980 USDT and sell it to the Put Option seller for the agreed-upon 2,000 USDT Strike Price. Settlements are automatically completed by Binance upon your confirmation.
Your net profit would be:
Payoff = 2,000 USDT (Strike Price) - 1,980 USDT (Spot Index price) = 20 USDT
Exercise Fee = Minimum [Exercise Fee Rate * Settlement Price * Contract Unit, 10% * Option Value] * Position Size = 10% of Option Value or 0.015% * Strike Price (whichever is lower) = Minimum [0.015% * 1980, 10% * 20] = 0.297 USDT
Net Profit = 20 USDT (Payoff) - 10 USDT (Premium) - 0.2973 USDT (Exercise Fee) = 9.703 USDT
In general, the payoff to a Put Option buyer on the exercise date is: MAX (Strike Price - Spot Index price, 0)
Basic Options Strategies
There are different options trading strategies based on various possible combinations of Call and Put Options contracts. Straddle and Strangle are some basic examples of such strategies.
Straddle - It involves buying a Call and a Put Options of the same asset with identical Strike Prices and expiration dates. It allows the trader to profit if the asset moves far enough in either direction. Simply said, the trader is betting on market volatility.
The following graph illustrates the payoff diagram for Straddle Options buyers:
Strangle - Similar to Straddle, it involves buying a Call and a Put Options of the same underlying asset with the same expiration dates.
The difference is that the Call and Put Options do not have the same Strike Prices. This difference in the Strike Prices generally makes Straddle a cheaper option strategy.

The following graph illustrates the payoff diagram for Strangle Options buyers: