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Binance Options: Understanding Options Prices

2020-04-29

Options trading can be intimidating at times. The complexities and financial jargon surrounding it make options trading out of reach for some retail users. In addition to the technical know-how, options traders need to understand how certain variables affect an option's price. Unlike trading in futures or spot markets, options traders must deal with these variables to be able to trade profitably. There are four main variables that options traders need to consider, they are the time to expiration, price of the underlying asset, price volatility, and the style of an option. 

1. Time to expiration 

Options are often used as a hedging tool against adverse movements in an underlying asset. It is a form of insurance that protects the option holder against risk. As with all types of insurance, to own it, you would incur either a one-time premium or recurring payments. 

Insurance premiums are based on several factors such as duration of coverage, the health risk of the insured and etc. In that regard, options work similarly to insurance. 

In the options market, you have various predetermined dates for when an option expires and these expiration dates directly impact the premium of an option. For instance, a 10-min call option on Binance would cost around 10 USDT while a 24-hr call option may cost 150 USDT. In other words, the longer the duration, the more money it will cost.  

Binance Options offers short-duration contracts, ranging from 10 mins to 1 day. This allows users to trade with expiry windows as small as 10 minutes apart, providing a wider selection of option trading strategies.

Binance options expirations displayed on Binance App

With Binance options, users are not constrained to holding long-term positions. It caters to active traders who focus mainly on price action, rather than the long-term fundamentals of Bitcoin. This style of trading attempts to profit from quick moves in market prices and volatility.

2. Price of the underlying asset & Strike Price

The second factor that affects the price of an option is the price of its underlying asset and the strike price. 

The relationship between the strike price and the price of its underlying asset directly impacts the option premium. For instance, in the case of BTC options, when the price of BTC goes up, call options should increase in value, and put options should decrease. Likewise, put options should increase in value, and call options should decline as the price of BTC falls.

This relationship between the strike price of an option and the current price of its underlying asset is also known as Moneyness. In options trading, terms such as in-the-money, out-of-the-money, and at-the-money describe the moneyness of options.

For instance, a call option is ‘out-of-the-money’ if its strike price is way above the price of the underlying asset. Conversely, a call option is ‘in-the-money’ if its strike price is below the price of the underlying asset. Meanwhile, a strike price that is the same as the price of the underlying asset is said to be ‘at-the-money’.

For example, if the price of Bitcoin is currently at $7000, the moneyness of BTC options will be as follows:

Option premiums are dependent on the ‘moneyness’ of its options. For example, an ‘out-of-the-money’ call option is priced cheaper than an ‘in-the-money’ or ‘at-the-money’ option as they possess a greater probability of expiring worthless. In contrast, an ‘in-the-money’ option is most expensive when compared to other options. 

Binance Options are always ‘at-the-money’, this is because Binance options are designed to track its underlying asset very closely. As such, with Binance options, users can only choose one strike price, which is equivalent to the price of BTCUSDT perpetual contract on Binance Futures. Thus, users need not go through the hassle of choosing over a range of strike prices and expiration dates. 

Typically, ‘at the money’ options have a better probability of turning into ‘in the money’ and once the trade direction goes in your favor, you would enjoy the benefit of Delta movement that is identical to the Spot movement.

3. Volatility

The third factor that goes into option pricing is volatility. Volatility is referred to as price swings in the underlying asset. A higher volatility means bigger price swings, and ultimately, more risk for the investor who owns the underlying asset.

Three-month volatility in BTCUSD

Source: Skew.com

BTCUSDT Daily Net-change

Source: Binance Futures

As shown, large price swings in BTC through mid-march resulted in a sudden surge in volatility. Subsequently, as price swings reduce, volatility normalized. 

As such, volatility plays a major in options pricing. If more risk is involved, options will be more expensive as options sellers will demand more premium for taking on more risk.

Let’s go back to the insurance analogy. Assume there are two insurance policy buyers, one is a perfectly healthy 20-year-old man who is a non-smoker and exercises regularly. The other is an obese middle-aged man who is an active smoker and has a medical condition. Now, who do you think will have to pay more for life insurance? Logically, the person who is at more risk of dying would have to pay more for life insurance. 

The same analogy applies to options. In periods where an asset displays high price volatility, its options will be expensive. Conversely, options will be cheap or at least, less expensive, if the underlying asset displays low price volatility. 

4. Type of option 

The final factor that affects options prices is the type of option. Options can be categorized into two main types, American and European style options. A European option can be exercised only at the expiration date whereas the American option can be exercised anytime before the expiration date when the option holder desires.

Binance Options are unique from existing crypto options as Binance Options are American-style while existing crypto options are European-style. This feature distinguishes Binance Options from others as American-style options allow users to exercise the options any time before the expiry date. In traditional options markets, American-style options are normally worth more than other types of options, this is because of the flexibility that it offers. Thus, it is common to have American-style options trading at a premium to European-style options.

Additionally, European options are less popular and often lack liquidity. In contrast, American options are high in demand due to the flexibility that it offers. Thus, American-style options contracts often are easily tradable in the market. In the case of Binance options, Binance is the primary liquidity provider of the product. This means that Binance options have an uncapped supply and users will always have quotations in any given period. 

The bottom line

While options are complex financial instruments, the variables that drive options prices are generally known and well-studied. The only exception is volatility, which changes according to market sentiment, thus, the volatility of the underlying asset remains a matter of estimation. Once you have understood the basic principles, you'll find that options can provide versatility and strategic alternatives that are necessary to profit in any market condition.