Exploring Crypto Futures & Options Contracts

The growing popularity of crypto trading derivatives like futures and options contracts underscores how the market is rapidly maturing to reach parity with traditional markets. 

Crypto derivatives are a key financial instrument that allows traders to speculate on price movements and hedge against their exposure to certain digital assets. With futures contracts, traders can lock in a definitive price at which they can buy or sell an asset later, while options give them the flexibility to do the same without obligation. 

These advanced tools allow experienced traders to achieve a larger return on investment and hedge against risk, with futures being more cost-effective thanks to the availability of leverage, and options considered much lower risk. So let’s take a closer look at how they work. 

Crypto futures vs crypto options

Futures and options are the two most popular financial instruments available to traders, known as “derivatives.” Each provides its own benefits and drawbacks. By understanding how these instruments work, traders can maximize profitability while more effectively protecting against risks. 

These instruments were once pretty rare in the crypto industry, but in recent years several key cryptocurrency exchanges have made them available to traders on their platforms. For instance, centralized platforms like Binance Futures , Coinbase Advanced , and VALR support futures contracts for hundreds of crypto assets, while GMX and dYdX are some of the most popular decentralized platforms for futures trading. 

For options trading, CEXs such as ByBit , Crypto.com , and StormGain all provide extensive support, while DEX options platforms include Deribit and Ribbon Finance .

What are futures?

Crypto futures are contracts agreed upon by a trader and exchange that give the former the right to buy or sell a digital asset at an agreed price on a specified future date. They’re quite different to regular spot trading, which is all about buying and selling assets at current market prices, giving traders the ability to speculate on where the market will head next. 

Futures contracts come with an expiration date, at which point the agreement must be executed, regardless of the asset price. 

We can understand Futures by looking at a simple example. Let’s imagine Bitcoin is trading at $100,000, and you think the price is going to increase. You can enter a contract to buy 1 BTC at $102,000 in one month from now. Should Bitcoin’s price rise to $110,000, you’ll be in a good position because you’ve already locked in the right to purchase at just $102,000. You can then sell that 1 BTC on the spot market for its current price of $110,000, making a profit of $8,000 in the process. 

On the other hand, you’ll lose should the price of BTC fall. If it drops to $95,000, you’re still forced to buy it at $102,000, meaning you’re paying significantly more than the current market rate. 

This is a fairly simple explanation, for futures contracts can get more complicated with the addition of leverage and perpetual contracts, which are agreements that don’t have an expiration date. Leverage involves borrowing funds from an exchange to increase your exposure in a futures contract, and it can potentially multiply your profits, but you’ll be required to put up significant capital to prevent your position from being liquidated, should the price of the asset go in the wrong direction. 

As for perpetual future contracts, these never expire, but once again a trader might be required to put up substantial amounts of capital to prevent liquidation. 

What are Options? 

In contrast to futures contracts, which come with the obligation to buy or sell, options are contracts without any obligation. They give traders more flexibility because they don’t have to do anything if the market moves against them, though they do have to pay a premium to take out the contract in the first place. 

The advantage is that the premium is relatively low, enabling traders to limit their losses while potentially benefiting from substantial profits if they guess correctly which way the market is headed. 

There are two kinds of options contracts – call options and put options. 

Call options give you the right to buy a specific amount of crypto at a predetermined price, called the strike price, either before or on the expiration date. A trader might buy a call options contract if they anticipate the price of an asset is going to increase, and if that happens as expected, and the price exceeds the strike price, they can buy it at an amount that’s much lower than its true value. They can then sell it on the spot market to profit from the price difference. 

However, should the price of the asset fall, the trader would choose not to execute the contract and simply let it expire. So they’re not obligated to purchase the asset at a price that’s higher than its market value. However, they’ll lose the premium they paid to take out the contract. 

Put options provide traders with the option to sell an asset at a specified price on or before a future date. Traders should buy put options if they believe the market is heading south and they expect the price of an asset to decline. They can then sell that asset at a price that’s above the current market rate, and then rebuy it for a much lower price to profit that way. Of course, if the asset price increases, the trader will let the contract expire, and once again they only lose the premium they paid. 

Choosing between futures and options

Traders should consider their profit goals, their level of risk tolerance and their general market outlook. The crypto exchange VALR provides some useful tips and insights that can help traders to decide in this blog post . It asks a number of key questions, and your answers can help to inform which derivatives strategy is most appropriate for your needs. 

For instance, your profit goals and risk tolerance are critical. If you’re willing to tolerate a significant risk in order to achieve enormous profits, then futures trading might be the most appropriate strategy for you, as the use of leverage provides more room to speculate on future price movements. 

Alternatively, if you’re looking to minimize your risk, and are happy with more incremental profits, an options contract might be a better choice. Additionally, options contracts give traders more flexibility, as they enable traders to speculate and hedge against risk, without any obligation to execute the trade. 

VALR also points out the need to consider exactly what it is you’re betting on. Are you betting on the price of an asset moving up or down? Are you simply trying to profit from volatile market conditions? Or do you want to hedge against your existing position? 

If you’re just betting on an asset price movement, a futures contract might be best as it can deliver significantly more profits, while if you’re just hoping to capitalize on volatility, an option contract will give you the flexibility to execute at just the right moment, which is especially useful if prices are constantly moving up and down. An options contract is also the main weapon used by traders to hedge against risk. 

Another vital consideration is the amount of capital you have available, and whether or not you want to maximize its efficiency, VALR says. 

Futures contracts, with the high leverage they afford, give traders the opportunity to increase their exposure with limited capital. On the other hand, options allow traders to control a large position with a smaller upfront cost. 

Finally, VALR mentions that traders need to consider how confident they are about the timing of an asset’s price movements. If you’re confident about both the direction the asset will move and the timeframe, then a futures contract, or a short-term options contract, is probably best. But if you’re not confident about the timing, but are sure the asset will move in the direction you want, then a perpetual futures contract or long-term options contract can be more beneficial. 

By assessing your trading goals, determining your risk tolerance, and considering the timeline for your investments, you’ll be able to decide which derivatives contract type is more appropriate. To succeed in trading, you must understand both your objectives and the various instruments that can help you to achieve them. 

Final thoughts

To summarize, traders need to consider various factors, including how much risk they’re willing to tolerate, how much money they hope to make, and their general market outlook. By understanding these factors, they’ll be able to make a more informed choice about whether to go with futures or options. 

In any case, understand that both types of derivative instruments can be extremely powerful tools for smart traders, enabling them to maximize their profits while limiting the risks they face.