4 ms·

So if you "thought" that Bitcoin will go over $50k - why not buy the Bitcoin itself now at $20k (or whatever it is today)? i.e. what is gained with the call opt

So if you "thought" that Bitcoin will go over $50k - why not buy the Bitcoin itself now at $20k (or whatever it is today)? i.e. what is gained with the call option here?

cardmagic 9y ago
Leverage
lucozade 9y ago
You're assuming that it's naked (in the technical sense) speculation. If they're covering a short position then this is just akin to insurance to limit the downside. Entirely sensible and the reason why they were invented in the first place.
- laurencei 9y ago
  Any chance of a ELI5 of this?
  - dagw 9y ago
    Let's say I'm convinced bitcoins will be worth at most $1k next year. Let's also say you have a bunch of bitcoins you're planning on sitting on for at least a year (since you're convinced the price is only going up and up). What you then can do is lend me your bitcoins for a year and charge me interest on that loan as a way to generate some cashflow on an asset you where just going to sit on anyway. So I'll borrow a bitcoin from you, sell it for $20k, and use some of that cash to pay you your interest. Now 1 year later I have to give you your bitcoin back. If I'm right, I can now buy a bitcoin for $1k on the market, give you the coins and pocket the difference as profits. On the other hand if bitcoins have gone up to $100k I'm screwed since I need a bitcoin to pay back my loan, and will have a loss of $100k-$20k = $80k. An option lets me lock in the price I have to pay for a bitcoin in the future. I know that no matter what happens to the price I need to buy a bitcoin one year from now. So by taking out a call I'm buying insurance that no matter what happens I will never have to pay more than $50k for that bitcoin and thus I've capped the maximum amount of money I can lose on the deal to $50k-$20k=$30k. Without that my losses are potentially infinite.
    - laurencei 9y ago
      cool - thanks.
      - lucozade 9y ago
        For completeness, there's a related argument as to why you'd want to sell a call option with a strike price that looks a long way from the current price (an out of the money option in the jargon). If you already own bitcoin with the price at 20k, you can sell the call option with the strike at 50k. You will immediately be given the premium. Now, if the price < 50k when the option expires you've made more money (the premium) than you would have done otherwise. If it does expire above 50k, you can sell your bitcoin and give (current price - 50k). As such, you don't lose money but you don't gain as much as you would if you hadn't written the option. This is called selling a covered call and is very common in the stock market. If you don't own the underlying asset i.e. enough bitcoin, this is called selling a naked option and is quite risky as you're exposed to the price going very high.
  - FabHK 9y ago
    If you just sell a call on BTC, you could lose a lot when BTC goes up. -(S-K)^+ becomes very negative as S goes up. That's selling a naked call. However, if you hold BTC, and you sell a call, you just give up some of the upside. S-(S-K)^+ just becomes K as S goes up. That's selling a covered call. As in so many areas of life, covered is safer than naked.
dagw 9y ago
Let's say you have $20k to invest and you're convinced Bitcoin will be $60k in one year. If you buy bitcoin for $20k and sell in a year for $60k, you've made $40k profit. If on the other hand you buy 10 $50k call options at $2k each then if Bitcoin hits $60k you'll get ($60k-$50k)*10 or $80k profit ($100k - $20k initial investment). Basically you're doubled your profits without increasing your investment. On the flip side if Bitcoin 'only' hits $40k, you'll have lost $20k if you bought the call (since calls are worthless if the asset doesn't reach the target price), but made $20k if you'd bought the bitcoin. Basically calls allow you to take bigger bets with less money up front.
- lucozade 9y ago
  To close out the comment DAG, this is the ELI5 for cardmagic's answer "leverage".
  - FabHK 9y ago
    Well, futures (or forwards) give you leverage. Options give you convexity (optionality, as it were), additionally.

So if you "thought" that Bitcoin will go over $50k - why not buy the Bitcoin itself now at $20k (or whatever it is today)? i.e. what is gained with the call option here?

cardmagic 9y ago

Leverage

lucozade 9y ago

You're assuming that it's naked (in the technical sense) speculation. If they're covering a short position then this is just akin to insurance to limit the downside. Entirely sensible and the reason why they were invented in the first place.

laurencei 9y ago
Any chance of a ELI5 of this?
- dagw 9y ago
  Let's say I'm convinced bitcoins will be worth at most $1k next year. Let's also say you have a bunch of bitcoins you're planning on sitting on for at least a year (since you're convinced the price is only going up and up). What you then can do is lend me your bitcoins for a year and charge me interest on that loan as a way to generate some cashflow on an asset you where just going to sit on anyway. So I'll borrow a bitcoin from you, sell it for $20k, and use some of that cash to pay you your interest. Now 1 year later I have to give you your bitcoin back. If I'm right, I can now buy a bitcoin for $1k on the market, give you the coins and pocket the difference as profits. On the other hand if bitcoins have gone up to $100k I'm screwed since I need a bitcoin to pay back my loan, and will have a loss of $100k-$20k = $80k. An option lets me lock in the price I have to pay for a bitcoin in the future. I know that no matter what happens to the price I need to buy a bitcoin one year from now. So by taking out a call I'm buying insurance that no matter what happens I will never have to pay more than $50k for that bitcoin and thus I've capped the maximum amount of money I can lose on the deal to $50k-$20k=$30k. Without that my losses are potentially infinite.
  - laurencei 9y ago
    cool - thanks.
    - lucozade 9y ago
      For completeness, there's a related argument as to why you'd want to sell a call option with a strike price that looks a long way from the current price (an out of the money option in the jargon). If you already own bitcoin with the price at 20k, you can sell the call option with the strike at 50k. You will immediately be given the premium. Now, if the price < 50k when the option expires you've made more money (the premium) than you would have done otherwise. If it does expire above 50k, you can sell your bitcoin and give (current price - 50k). As such, you don't lose money but you don't gain as much as you would if you hadn't written the option. This is called selling a covered call and is very common in the stock market. If you don't own the underlying asset i.e. enough bitcoin, this is called selling a naked option and is quite risky as you're exposed to the price going very high.
- FabHK 9y ago
  If you just sell a call on BTC, you could lose a lot when BTC goes up. -(S-K)^+ becomes very negative as S goes up. That's selling a naked call. However, if you hold BTC, and you sell a call, you just give up some of the upside. S-(S-K)^+ just becomes K as S goes up. That's selling a covered call. As in so many areas of life, covered is safer than naked.

dagw 9y ago

Let's say you have $20k to invest and you're convinced Bitcoin will be $60k in one year. If you buy bitcoin for $20k and sell in a year for $60k, you've made $40k profit. If on the other hand you buy 10 $50k call options at $2k each then if Bitcoin hits $60k you'll get ($60k-$50k)*10 or $80k profit ($100k - $20k initial investment). Basically you're doubled your profits without increasing your investment. On the flip side if Bitcoin 'only' hits $40k, you'll have lost $20k if you bought the call (since calls are worthless if the asset doesn't reach the target price), but made $20k if you'd bought the bitcoin. Basically calls allow you to take bigger bets with less money up front.

lucozade 9y ago
To close out the comment DAG, this is the ELI5 for cardmagic's answer "leverage".
- FabHK 9y ago
  Well, futures (or forwards) give you leverage. Options give you convexity (optionality, as it were), additionally.