Interested in trading bitcoin options through regulated marketplaces?
You may soon be able to do so, after a decision the U.S. Commodity Futures Trading Commission (CFTC) made in July 2017.
The government agency cleared the way for digital currency trading platform operator LedgerX to become the first federally regulated U.S. company to trade and clear bitcoin options.
Following this CFTC decision, LedgerX planned to start offering bitcoin options in either September or October 2017, CEO Paul Chou told Bloomberg.
Options and Hedging
As an investor, you know that options represent a valuable tool you can use to either manage risk (hedge) or generate appealing returns by speculating. Through hedging strategies, you can leverage options contracts to help manage the potential loss associated with holding digital currencies.
Any time you purchase an options contract, you receive the ability to buy or sell an underlying asset, in this case digital currencies, for a predetermined price within a specific time frame.
Put options, which give you the ability to sell the underlying asset, can be quite helpful in managing downside risk. The value of these options depends on several variables, including the value of the underlying asset.
If you hold bitcoin and opt to purchase put options on the digital currency, a decline in bitcoin’s price will cause these options to climb in value, therefore helping reduce your downside risk associated with your holdings.
Call options, on the other hand, give you the opportunity to generate appealing returns.
These contracts, which grant you the right to buy the underlying digital currency for a set price within a predetermined time frame, can rise in value very quickly when the underlying asset appreciates.
Generating Strong Returns with a Modest Downside Risk
While no digital currency options exist at the time of report, it is simple to illustrate the sharp returns you can receive from these options by giving an example involving stocks.
If shares of Microsoft (MSFT) are trading at $50, for example, you could purchase 1,000 shares for $50,000.
Alternatively, you could buy MSFT call options that have a strike price of $50 and expire one month from now.
For example, if you purchased 10 MSFT Sep 50 Calls for $2 in August, you would be acquiring the right to buy 1,000 shares of MSFT (10 contracts times 100 shares per contract) for a total of $2,000, since the $2 price is listed on a per-share basis.
Should MSFT fail to rise above $50 before the contract’s expiration date, your maximum loss would be $2,000.
However, if the price of MSFT rose to $75, for example, you would have the ability to purchase 1,000 shares of MSFT – with a value of $75,000 – for $50,000, thereby netting a $25,000 profit.
Keep in mind that most options contracts are never exercised. Generally, options either expire worthless or their owners sell them.
Selling an option contract that has risen in value can present you with significant opportunity. If you purchase a call option on bitcoin, for example, and the digital currency appreciates notably, you could sell this call for a handsome profit.
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