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Basics

Option

  • An option gives buyers the right, but not the obligation, to buy (in the case of a call option contract) or sell (in the case of a put option contract) an underlying asset (such as BTC or ETH) at an agreed-upon price (strike price) and at an expiration date, where buyers pay a premium for the rights granted by the contract.
  • There are two types of vanilla options: Call and Put, and two option styles based on when the options can be exercised: American and European.

Call Option

  • Buying (long) a call gives you the right, but not the obligation, to buy the contract size of the underlying asset at the option's strike price.
  • The value of a call option should increase as the price of the underlying asset increases. Each call option has a bullish buyer and a bearish seller.

Put Option

  • Buying (long) a put gives you the right, but not the obligation, to sell the contract size of the underlying asset at the option's strike price.
  • The value of the put option should increase as the price of the underlying asset decreases. Each put option has a bearish buyer and a bullish seller.

American Option

  • It can be exercised any time before the expiration date of the option.

European Option

  • It can only be exercised on the expiration date of the option.

Option Premium

  • It is the current market price of an option contract, the income received by the seller (writer) of an option contract from another party.
  • Option Premium = Intrinsic Value + Extrinsic Value

Intrinsic Value

  • Intrinsic Value is the difference between an option's strike price and the spot price of the underlying asset.
  • For a call option, it is calculated by subtracting the strike price from the spot price of the underlying asset (spot price - strike price).
  • For a put option, it is calculated by subtracting the spot price of the underlying asset from its strike price (strike price - spot price).

Extrinsic Value (Time Value)

  • Extrinsic value is the difference between the option premium and its intrinsic value. It is also known as "time value" as duration until an option expires is the main factor affecting premium.
  • In general, extrinsic value decrease when a contract closes to its expiration date as there is less time for the underlying asset to move favorably.
  • Another factor that affects extrinsic value is implied volatility. If the implied volatility increases, the extrinsic value will increase.

Implied Volatility (IV)

  • Implied volatility is a metric to estimate the price of an underlying asset that may move over a specified period. Options with high implied volatility have higher premiums and vice versa.
  • Keep in mind that IV doesn't predict the direction in the price change. For example, high volatility means a large price swing, but the price could move upward (very high), downward (very low), or fluctuate between the two directions.

Underlying Asset

  • An underlying asset is a cryptocurrency on which derivative instruments, such as futures and options, are based. For instance, BTC or ETH.

Quote Asset

  • The asset is used to price the underlying asset. We use USDC as the quote asset.

Strike Price

  • A strike price is a specific price at which a derivative contract can be bought or sold when it is exercised.
  • For calls, the strike price is where the security can be bought by the option holder.
  • For puts, the strike price is the price at which the security can be sold.

Expiration Date

  • It is the final date on which the derivative is valid. After that time, the contract has expired.

Contract Size

  • The amount of the underlying asset can an option holder exercises for.

Exercise

  • It means an option buyer utilizing the right to buy or sell the underlying asset specified in an option contract.
  • Moneyness tells option holders whether exercising will lead to a profit. There are many forms of moneyness, including: in the money, at the money, or out of money.

In the Money (ITM)

  • A call option is ITM when its strike price is less than the spot price of the underlying asset (strike price < spot price).
  • A put option is ITM when its strike price is greater than the spot price of the underlying asset (strike price > spot price).
  • Its premiums are composed of two factors: intrinsic value and extrinsic value (time value).

At the Money (ATM)

  • A call or put option is ATM, or "on the money" when its strike price is at or very near to the spot price of the underlying asset (strike price = spot price).
  • ATM options have no intrinsic value but still have extrinsic value prior to expiration.

Out of Money (OTM)

  • A call option is OTM when its strike price is greater than the current underlying asset's price (strike price > spot price).
  • A put option is OTM when its strike price is less than the underlying asset's current price (strike price < spot price).
  • Its premiums consist solely of extrinsic value, same as ATM options.
Moneyness
Call
Put
Strike price > Spot price
Out of Money (OTM)
In the Money (ITM)
Strike price = Spot price
At the Money (ATM)
At the Money (ATM)
Strike price < Spot price
In the Money (ITM)
Out of Money (OTM)

Open Interest

  • Open interest is the total number of outstanding derivative contracts, such as options or futures that have not been settled for an asset.
  • Increasing open interest represents new or additional money coming into the market while decreasing open interest indicates money flowing out of the market.