Call vs Put Options
A call option is an option contract giving the holder the right, but not the obligation, to buy a specified amount of an underlying asset at a specified price within a certain time. The predetermined price the call option buyer can buy at is called the strike price.
For example, a call option contract may give a holder the right to buy 1 ETH at $1000 up until the expiry date in four weeks. There are many expiration dates and strike prices for traders to choose from.
- Potential Profit: Unlimited as the profit of the underlying asset increases
- Potential Loss: Limited to premium paid for a call option contract
Buying Call Option
The price of a call option is called the premium. It is the price paid for the rights that the call option provides. If at expiry the underlying asset is below the strike price, the call buyer loses the premium paid. This is the maximum loss.
If the underlying price is above the strike price at expiry, the profit is the current asset price minus the strike price and the premium.
For example, if ETH is trading at $1500 at expiry, the strike price is $1000, and the option costs the buyer $10, the profit is $1500 - ($1000 + $10) = $510. If at expiry ETH is below $1000, then the option buyer loses $10 (the premium paid) for each contract they bought.
By purchasing a call option on ETH instead of directly purchasing ETH, you are taking advantage of leverage; thus allowing you to use less money to gain positive exposure to ETH rather than using more money to purchase ETH directly. You can profit if the Ethereum price rises, without taking on all of the downside risks that would result from owning ETH. Your losses are limited to only what you paid for the call (ie the premium) versus the potentially larger losses equaling the total decline in ETH price had you just bought ETH directly.
If ETH price remains even or moves only slightly, you lose some (or all) of the premium you paid for the call. Then you can decide to sell the call for a loss. However, if the ETH price goes higher, you profit from the increase. Then you have to decide whether you want to exercise your right to buy ETH at the lower price or just sell the call and collect your profit.
Let’s assume ETH is currently trading for $1000. You would like to buy 10 ETH. You could buy 10 ETH and have $100,000 of risk exposure in the market along with coming up with $100,000 worth of capital. Or, you could buy 10 ETH calls with a $1000 strike price for $20 and have a similar exposure but do so with only $2000 ($20 X 10 = $2000).
By purchasing the call you are saying that by expiration you anticipate ETH to have risen above the break-even point: $1020, $1000 strike price + $20 (the option premium paid). The profit potential is unlimited as the ETH price continues to rise above $1020. The risk for the call purchase is limited entirely to the total premium paid, $2000, no matter how low ETH price declines.
Before expiration, if the call purchase becomes profitable you are free to exercise the right to buy ETH at $1000 or to sell the option to realize the gain. On the other hand, if your bullish outlook proves incorrect, the call might be sold to realize a loss less than the maximum.
A put is an option contract giving the holder the right, but not the obligation, to sell a specified amount of an underlying asset at a specified price within a certain time. The pre-determined price the put option buyer can sell at is called the strike price.
- Potential Profit: Substantial profit potential and increases as the level of the underlying asset decreases towards zero
- Potential Loss: Limited to premium paid for a put option contract
Buying a Put Option
The price of a put option is called the premium. It is the price paid for the rights that the put option provides. If at expiry the underlying asset is above the strike price, the put buyer loses the premium paid. This is the maximum loss.
If the underlying price is below the strike price at expiry, the profit is the strike price minus the current asset price and the premium.
For example, if ETH is trading at $900 at expiry, the strike price is $1000, and the option costs the buyer $10, the profit is $1000 - ($900 + $10) = $90. If at expiry ETH is above $1000, then the option buyer loses $10 for each contract they bought.
A put option guarantees the owner the right, but not the obligation, to sell the asset at the strike price at any time until the option expires, no matter how low ETH declines in value. And just as with other forms of insurance the holder pays a premium for this protection, in the form of a premium paid for the put. Buying a put option equivalent to the amount of asset held is called a protective put strategy.
Let’s assume ETH is currently trading at $1000. You own 10 ETH and you don’t necessarily want to sell your ETH, but you want to limit your losses if it were to drop below $1000. To hedge this position, you could buy 10 puts with a $1000 strike price for $10 each and pay $100 (10*10) to have the ability to sell your ETH at $1000 if the price of ETH were to drop below that amount. With the protective put, you pay a premium to have the right to sell your ETH in case the price declined or there was a dip in the markets before the expiration.
There are two things to keep in mind when buying put options to protect an ETH position. First, you can wait and see how ETH price performs for as long as you want, up to the end of the life of your option. Second, even if ETH drops below $1000, you may not want to sell it right away. You can wait to see if the price rebounds. That’s something you can’t do with stop orders. However, keep in mind that the security does come at a cost since you pay a premium to own the put.