Despite ongoing vaccination efforts and pandemic assistance, the world economy looks remarkably different from a year ago. The new economic landscape and the continuing uncertainty have accelerated the shift away from traditional financial institutions.
As the economy tries to roar in high gear from a standing start, the cryptocurrency world is taken to the main phase. It has cemented itself as a recognized asset class of large asset managers, investment banks and hedge funds. As the pace of mainstream adoption continues to take the financial world by storm, it also paves the way for investors to explore a new frontier ̵
Related: Here’s how traders use call options to increase their Bitcoin holdings
What are options?
Option are financial contracts that allow investors to buy or sell the underlying asset at a fixed price at a future date. This allows investors to take directional bets on an asset’s price movement. Investors who expect the asset to be valued at value can buy call options that they will profit from if the asset’s market price exceeds the strike price. In contrast, if they believe that the asset will be impaired in value, they can buy put options, which will result in profit when the asset’s market price falls below the strike price.
Once these conditions are met, investors can choose to exercise their option, requiring the issuer to buy or sell the underlying asset from or to the investor at the redemption price. Or they can simply exchange their opportunities for others to make a profit.
Truth about opportunities
There are several features associated with options that make them more palatable to investors, especially in an volatile market. With options, investors are able to gain exposure to larger positions at a fraction of the price. For example, consider buying 100 shares in a stock for $ 50. To be in this position, an investor must have $ 5,000 in capital. With options, however, costs can be significantly reduced. The same investor can get the same exposure for a stock or cryptocurrency by buying an option for a fraction of the price, say with a premium of $ 150.
Options are a powerful tool to enable investors to take advantage of market volatility and enable investors to participate in the markets while freeing up capital so that they can diversify their strategy and take a larger number of positions.
The options also allow investors to gain exposure to market volatility. Since the price of an option is directly correlated with market volatility, options tend to become more expensive in a volatile market. Thus, an investor who has a long position in an option contract also stands to gain on the volatility of the market.
The biggest issue for options, however, is their use as risk management products. Investors can buy put options (or bet against the market) to hedge their portfolio when they are uncertain about the market’s upward position. This is like buying insurance on your portfolio to protect it from market volatility or downward movements.
Related: 10 tips to keep your crypto portfolio profitable during a crisis
Institutional madness for options and crypto
As institutional interest continues to grow in the cryptocurrency markets, so does institutional appetite for cryptocurrencies. Strategic investors have taken refuge in the idea that options allow them to take advantage of the volatility of the crypto market to capture high profits while keeping them away from higher risk investments. The volatile nature of crypto markets creates an urgent need for investors to be able to diversify their strategies and hedge their positions while still gaining exposure to upside.
Option markets have given investors a chance to play the course, invest strategically and study the market. Even during what some call a bear market, this has kept activity high.
Related: The remaining steps to ordinary institutional investment
Bucks do not stop at institutions
The power that options offer to individuals is also being realized by an increasing number of retail investors, even in the midst of global economic uncertainty. According to Trade Alert, 2020 was a record year for the options market in terms of traded volume with 7.47 billion traded contracts. This trend continued with conviction in early 2021.
Surprisingly, the majority of the increase in volume was contributed by retail investors. An article by Barrons highlighted that option brokers like Schwab have seen a 116% increase in the options traded. It is estimated that 60% of all options traded are from retail investors, as evidenced by the fact that the size of the position is less than 10 contracts. In fact, the number of trades with a single contract has doubled in the same time period.
Related: Discovery of financial literacy: Crypto carries fees for retail investments
As we evolve through 2021, big names like Goldman Sachs have also announced that they are expanding their cryptocurrency presence by offering options trading in Ether (ETH) after seeing a huge institutional demand. These products also apply to their retail customers and are sure to reduce some of the leverage in the system, creating an easy ramp for investors.
Today, centralized exchanges are better equipped to handle retail demand for options. They do not suffer from network load on Ethereum, leading to immediate execution of trades with lower fees.
It does not exclude the innovations that come with the accelerated rate of decentralized financing. DeFi has disrupted many traditional financial industries and it seeks to make options more readily available. In the future, decentralized exchanges will play a key role in connecting retail investors with options as its ecosystem continues to evolve.
Related: DeFi proved to be resilient during the market crises of March 2020 and May 2021
With the economic impact of the global pandemic expected to last until 2025, cryptocurrency markets will no doubt remain volatile. DeFi applications and centralized exchanges are working diligently to bring more and more cryptocurrencies to the options market and are evolving to simplify complicated trading strategies for investors.
This article does not contain investment advice or recommendations. Every investment and trading movement involves risk, and readers should conduct their own research when making a decision.
The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Pankaj Balani has over eight years of experience as a business manager and derivatives trader, and he has dedicated the last two years to building the Delta Exchange, a next-generation derivative exchange where traditional financial instruments and cryptocurrency trading intersect. Balani is a UBS alumni and has gained financial, derivatives and quantitative financial experience through his positions in Edelweiss Asset Management and Elara Capital. He graduated from the Indian Institute of Technology in Delhi with a degree in engineering physics and obtained an MBA from Indian School of Business.