Binance Options: Understanding Options Prices
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Key Takeaways:
Options are often used as a hedging tool against adverse price movements in an underlying asset.
Options traders need to understand the different variables that affect an option’s price.
Time to expiration, price of the underlying asset, and volatility are the three main variables that options traders should consider.
Options trading can be intimidating at times, especially to newcomers. The seemingly complex mechanics and dense financial jargon surrounding these financial instruments make options trading out of reach for many retail investors. In addition to the knowledge of the technical aspects of trading, options traders must understand how certain variables affect options’ prices.
Options traders deal with different variables than those who trade on the futures and spot markets. There are three main variables that options traders need to consider: the time to expiration, the price of the underlying asset, and price volatility.
1. Time to Expiration
Options are often used as a hedging tool against adverse price movements in an underlying asset and can be thought of as a form of insurance. As with all types of insurance, you 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 others. In that regard, options work similarly to insurance.
In the options market, there are various predetermined dates for when a contract expires, and these expiration dates directly impact the premium of an option. For instance, a 1-day call option on BTC would cost around 150 USDT, while a 1-week call option on BTC may cost 1000 USDT. In other words, the longer the duration, the more it will cost.
Binance Options offers expiries ranging from Dailies and Weeklies to Monthlies and Quarterlies.
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 these two prices directly impacts the option’s premium.
For instance, when the price of BTC goes up, BTC 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 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. A strike price that is the same as the price of the underlying asset is said to make the option at-the-money.
To illustrate, if the price of bitcoin stands at $7,000, the moneyness of BTC options will be determined as follows:
Option premiums are dependent on the moneyness of the contracts. An out-of-the-money call option is priced cheaper than an in-the-money or at-the-money option as it has a greater probability of expiring worthless. Naturally, an in-the-money option is the most expensive.
3. Volatility
The third factor that goes into option pricing is volatility, or the magnitude of the swings of the underlying asset’s price. A higher volatility means bigger price swings, and ultimately, more risk for the investor who owns the underlying asset.
Volatility plays a major role in options pricing. If more risk is involved, options will be more expensive as options sellers will demand a larger premium for taking on more risk.
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.
The Bottom Line
While options are complex financial instruments, the variables that drive their prices are generally well-known and relatively straightforward. Perhaps the only exception is volatility, which remains a matter of estimation. Once you have understood the basic principles of price formation, you'll find that options can provide versatility and act as a hedging tool against adverse price movements.
Read the following helpful articles for more information about Binance Options:
(FAQ) What Are Binance Options
And many more Binance Futures FAQ topics…
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