Bitcoin Options Explained: Understanding Calls and Puts
Bitcoin options might sound complex, but they’re simpler than you think. This guide breaks down the theory of bitcoin call and put options. By the end, you’ll understand how they can help traders speculate on bitcoin’s price moves – or earn option income. Let’s jump in.
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What are bitcoin options?
An option is a type of financial derivative contract. It lets you buy or sell bitcoin (or any other asset) at a pre-agreed price on or before a certain due date. That pre-agreed price is called the strike price, and the option due date is known as the expiration date.
You can think of options like a reservation. Here, you “reserve” bitcoin for a future date, at a price agreed today. But this reservation doesn’t mean you have to buy or sell bitcoin – remember, it’s an “option”.
Now, it’s worth pointing out that options aren’t free. You need to pay a premium up front in order to buy them. And that premium will reduce any profit you make.
Bitcoin call and put options, in a nutshell
There are two main types of options when it comes to bitcoin:
Call option: you would typically buy a bitcoin call option if you’re bullish on the bitcoin price. A call option gives you the right to buy bitcoin at the strike price. If bitcoin trades above the strike price, you have the option to buy it “on the cheap” and earn a profit.
But the more common thing to do is to just “close out” your call option by selling the option itself. This way, you capture the gains without having to buy bitcoin directly.
Put option: you would normally buy a put option if you’re bearish on bitcoin. A put option is the opposite of a call option – it gives you the right to sell bitcoin at the strike price. So if bitcoin’s price drops below the strike price, you get to sell it for more than it’s worth.
And that difference can earn you a profit. Again, it’s more common to “close out” the put option by selling the option itself.
Example: you buy a bitcoin call option
Assume the bitcoin price is $90,000 per coin today, and you think its price will climb above $100,000 in the future.
Instead of buying regular bitcoin, you pay $5,000 (the premium) for a bitcoin call option. The call option has a strike price of $100,000 per bitcoin. If the price gets above that level, you can buy bitcoin for less than its worth – or just close out your option and book the profits.
The option payout diagram below shows how the bitcoin price could change your fortune by the call option expiration date:
If bitcoin drops below $100,000, your call option becomes worthless – or “out of the money (OTM)”. The option has no value since the bitcoin price is below the strike price (you can’t use your option). But here’s the good news: you can’t lose more than the $5,000 premium you paid for the option (your maximum loss).
Now, if the bitcoin price is $105,000, you’re essentially breaking even on your trade. Your call option is “in the money (ITM)” because bitcoin is above the $100,000 strike price. So, you earn $5,000 from the call option. But remember, you still paid $5,000 for the premium – so you end up with zero overall.
Once bitcoin gets above $105,000, you cover the premium – and start turning a profit on your call option. In theory, that profit could be “unlimited” as bitcoin can keep rising. The higher it goes above $105,000, the more profit you make.
Example: Bob sells a bitcoin call option to you
Some traders sell options instead of buying them. This way, they can earn the premium instead of paying it. But there’s no free lunch here: option sellers can lose money fast if the price moves against them.
Assume you sold your $100,0000 bitcoin call option from earlier to your friend Bob – who took the other side of the trade. Bob would earn that $5,000 premium, but risks losing money if the bitcoin price rockets higher.
Here’s Bob’s option profit or loss diagram:
If bitcoin stays below $100,000, you won’t use up your worthless call option. That means Bob gets to keep the full $5,000 premium as profit.
On the other hand, if bitcoin rises to $105,000, Bob would break-even as the seller (just like you did as the buyer). You would exercise your call option to buy a $105,000 bitcoin from Bob for $100,000 – so he’d be short $5,000. But the $5,000 premium Bob earned upfront would cancel out his loss.
Things start to get painful for Bob if bitcoin gets above $105,000. His losses climb with every dollar higher. In theory, Bob’s maximum loss is unlimited because bitcoin can keep rising.
Example: you buy a bitcoin put option
This time, you’re leaning bearish on bitcoin – and you think its price will go lower. You pay $5,000 (the premium) for a put option with a strike price of $80,000 per bitcoin. This gives you the right to sell bitcoin at $80,000, even if the market price goes lower.
The option payout diagram below shows how bitcoin’s price could impact your bottom line:
If bitcoin stays above $80,000, your put option is out of the money (OTM). The option has no value because the market price is higher than your strike price (i.e. you have no reason to use your option). But just like with the call option, your maximum loss is limited to the $5,000 premium you paid for the option.
And if bitcoin drops to $75,000, you’d make a $5,000 on your put option – now in the money (ITM). That’s because you can sell bitcoin for $80,000 (when it’s worth only $75,000). But after factoring in the $5,000 premium, you break even.
If bitcoin heads below $75,000, that’s all profit. The bigger the drop, the bigger your gains.
In theory, bitcoin could crash to zero – and your put option would net $70,000 ($75,000 less the $5,000 premium). But if it really did go to zero, the whole bitcoin options market would implode – and you’d probably lose anyway.
Example: Alice sells a bitcoin put option to you
Since you bought your $80,000 put option from Alice, she earns the $5,000 premium.
The hockey stick diagram below maps out Alice’s potential payout scenarios:
If bitcoin holds above $80,000, you won’t exercise the worthless put. So, the $5,000 premium is all profit for Alice.
But if bitcoin dropped to $75,000, you would exercise your option. And Alice would lose $5,000 from the put to break-even over all.
Below $75,000 is when things get risky for Alice. The lower bitcoin goes, the greater her loss.
Call and put option payout summary table
Here’s a summary of the different payouts for option buyers and sellers – depending on the bitcoin price. Notice how options are a zero sum game – when the buyer wins, the seller loses (and visa versa):
| Outcome | Option Buyer | Option Seller |
|---|---|---|
| Break Even | Buyer breaks even when the price moves enough to cover the premium cost (upward for calls, downward for puts). | Seller breaks even when the premium earned offsets any loss from price movement. |
| Max Profit | Calls: Unlimited if price rises; Puts: Grows as price falls. | Limited to the premium earned upfront. |
| Max Loss | Limited to the premium paid. | Unlimited for calls (if price rises) or increasing for puts (if price drops significantly). |
Why trade bitcoin options?
People trade bitcoin options for three main reasons:
First, to hedge against price drops. Sure, bitcoin’s price has gone up over time, but it’s not always smooth sailing. The world’s biggest crypto is massively volatile, and its price can drop hard and fast sometimes. For example, some investors might buy bitcoin put options to protect the dollar value of their bitcoin during uncertain times. If bitcoin drops, they can earn money from the put option to offset their losses. We call this a “protective put”.
Second, to speculate on bitcoin price moves. Some traders buy options to bet on bitcoin’s price going up or down. If they guess right, they can make money without actually trading bitcoin itself.
Third, to earn income from selling options premiums. Experienced traders sometimes sell options to earn premiums. This can generate income but comes with risk – just ask Alice or Bob.
As usual, none of this is investment advice. If you liked this piece, check out my free newsletter for how-to guides and investment insights across crypto, stocks, metals, and more.
Key takeaways
- Bitcoin options let investors speculate on the bitcoin price without having to buy or sell the crypto itself.
- If bitcoin’s price goes up, a call option gives you the right to buy bitcoin cheaper.
- If bitcoin’s price goes down, a put option gives you the right to sell bitcoin for more.
- When you buy bitcoin options (calls or puts), you pay an upfront fee (the premium). Your upside potential is high if the bitcoin price moves in your favor.
- You can also sell bitcoin options to earn the premium. But if the price moves against you, your losses could be big.
