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Options on bitcoin futures just launched. Here's what you need to know

Scott Nations, Contributor
A customer enters the offices of La Maison du Bitcoin bank in Paris, France.
Christophe Morin | Bloomberg | Getty Images

They're finally here. Exchange-traded bitcoin options launched Monday on the Chicago Mercantile Exchange.

Traders of all stripes have been desperate for exchange-traded options on bitcoin because options can be used to define risk while expressing nearly any market thesis and it is that ability to limit losses that is so important in bitcoin, which saw a 1,900% rally in 2017 followed by an 82% break before bottoming late in 2018.

Traditional options allow the buyer of the option to purchase the underlying asset in the case of a call option or sell the underlying in the case of a put option. Options on futures are just a bit different in that the owner of a call option has the right at option expiration to take a long position in the bitcoin futures contract traded at the CME, while the owner of a put option has the right to take a short position in those bitcoin futures.

Regardless of the underlying instrument, the ability to define risk comes at a cost. Options on bitcoin futures are incredibly expensive as you would expect from anything with this sort of volatility. Traders usually refer to the cost of an option in terms of "implied volatility," or the amount of volatility implied by that current price of the option.

Options on bitcoin futures are implying an extreme amount of volatility. Just after midday on Monday, the $8,000-strike put options expiring in April were trading at 72% implied volatility, suggesting that traders believe bitcoin is likely to be between $6,965 and $9,940 when those April options expire. That's a range of 37% with bitcoin futures at $8,130. In comparison, the at-the-money April options for the S&P 500 are trading below 12% implied volatility.

The buyer of a $9,000-strike call option expiring in April would have to pay about $1,075 for the call, meaning bitcoin futures would have to be above $10,075 for that call purchase to be profitable at expiration. The buyer of an $8,000-strike put option expiring in April would have to pay about $1,165, meaning bitcoin futures would have to be below $6,835 at expiration for the put purchase to be profitable. That would really require some movement.

Until options on bitcoin futures gain a deeper following, any trader will face a market — meaning the bid for any option and the offer price for that option — that is very wide. For example, the market for those April $8,000 put options is about 250 points wide.

That doesn't mean option sellers will have it any better off. The seller of a naked call option would face unlimited losses if bitcoin were to resume the rally it enjoyed in 2017.

Options on bitcoin futures will likely be a great tool for speculators in the cryptocurrency space. Speculators in other asset classes have known for a long time that options offer the ability to limit losses and create unique payoff profiles. And it's always good for investors and speculators to have more options.

Scott Nations is a CNBC contributor and president of Nations Indexes, a financial engineering firm.

*Views are as of 1/13/2020 and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

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