Options Basics

Options trading offers a flexible way to manage risk, speculate on market movements, and diversify your investment strategy. Let's dive into the foundational aspects of options trading, unravel the key terminology, and explore real-world scenarios for trading Call and Put options before talking about exactly how Eve Exchange options trading works (see next section).

Understanding the Structure of Options Trading

Options are derivatives that give you the right, but not the obligation, to buy (Call option) or sell (Put option) an underlying asset at a predetermined price (strike price) within a specified time frame (expiry date).

These contracts provide you with the flexibility to profit from both rising and falling markets, making them a powerful tool for managing risk and maximising returns.

Key Terminology Explained

• Premium: The price you pay to purchase an options contract.

• Expiry: The date at which the options contract becomes void. After or upon this date, the right to buy or sell the underlying asset expires.

• Strike Price: Also known as the exercise price, it's the predetermined price at which the underlying asset can be bought or sold when the option is exercised.

• Underlying Asset: The security, stock, index, or Cryptocurrency on which the options contract is based.

• Call Option: A contract that gives you the right to buy the underlying asset at a specified strike price before or on the expiry date. Effectively, a Call is a Long (bullish trade).

• Put Option: A contract that gives you the right to sell the underlying asset at a specified strike price before or on the expiry date. Effectively, a Put is a Short (bearish trade).

Real-Life Examples: Call vs. Put Options

Example 1: Call Option

Imagine you're an experienced crypto trader who closely follows the top ten coins. You've been analysing a particular coin and foresee a bullish announcement around the corner. To capitalise on this potential uptrend, you might purchase a Call option on that coin. If the coin’s price indeed rises, you stand to gain from the price difference between the market value and the lower strike price, while only risking the premium you paid.

Example 2: Put Option

Now, consider a situation where you're an investor concerned about potential market volatility. You hold several top crypto assets, and you're worried about a market downturn. To hedge your investments, you could purchase Put options for those assets. If the market does fall, the value of your Put options could offset losses in your portfolio, providing a measure of financial protection.

Conclusion

Whether you're looking to speculate, hedge, or diversify, options can empower you in a similar way to Futures or Perpetual Swap Contracts, however, with options your risk is capped at how much you paid for the premium, which is one of the reasons options are the most popular form of derivatives in CeFi.

In the next section, we start breaking down exactly how options work on Eve Exchange.