Taking a Directional View on BTC Price Movements with Binary or One-touch Options
5 SEP 2024 | VIEWS | 3 MIN READ
Introduction
Binary and one-touch options are financial instruments that provide a fixed payout based on the outcome of a yes/no proposition. These options are considered ‘exotic’ due to their unique payoff structure, but in practice provide a more straightforward avenue to bet on price movements.
Understanding Binary & One-touch Options
A binary option has an all-or-nothing payout structure.
- Binary call option: Trader bets that the underlying asset’s price is above the strike price at expiration. If so, they receive a defined payout. If not, they would only forego the premium paid upfront.
- Binary put option: Trader bets that the underlying asset’s price is below the strike price and the payout profile reverses.
See IG’s “Digital options definition” for more detailed explanation of the mechanics of binary options.
One-touch options behave very similarly to binaries, with the exception that the payout is triggered if the strike price is reached at any point before expiration.
Application in Bitcoin Trading
Bitcoin, known for its volatility, presents a compelling case for the use of digital options. Traders can leverage digital options to speculate on Bitcoin’s price movements without needing to deal with the complexities and risks of holding the underlying asset, such as the risk of liquidation.
Imagine a trader, Alex, who believes that Bitcoin’s price will rise above $100,000 by the end of December due to a positive view of the market. Instead of buying Bitcoin directly or purchasing traditional options, Alex opts for a binary call option with a strike price of $100,000 and an expiration date of December 27th 2024.
Contract Specifications
- Underlying: BTC
- Strike price: $100,000
- Expiration date: Dec 27th, 2024
- Initial premium payment: $50,000
- Payout: $587,500
Binary Outcomes
- Outcome 1: If Bitcoin’s price exceeds $100,000 at expiration, Alex receives a fixed payout; $587,500.
- Outcome 2: If Bitcoin’s price is below $100,000 at expiration, Alex receives nothing, losing only the premium paid for the option. In this case: $50,000.
This straightforward payoff structure allows Alex to capitalize on their market prediction with a known risk ($50,000) and a predetermined reward ($587,500).
Alternative Approach: Perpetual Futures
Consider another trader, Charlie, who holds the same view that Bitcoin will trade over $100,000 by the end of December. They opt to express this view with Perpetual futures on 5x leverage, again using $50,000 to place the trade via funding a margin account.
Contract Specifications
- Underlying: BTC
- Leverage: 5x
- Initial margin: $50,000
- Position size: $50,000 * 5 = $250,000
- Maintenance margin: $50,000
With initial margin of $50,000, and 5x leverage, Charlie controls a $250,000 position. If their equity drops to the maintenance margin of $50,000, they would lose the entire initial margin, and the position will be liquidated.
In this case, the market needs to drop by only 20% from the entry price for the position to be liquidated. Even if the market closes over their year-end target, they could be liquidated well beforehand.
Advantages of Binary & One-touch Options in Bitcoin Trading
1. Defined Risk and Reward: The fixed payout structure provides clear expectations for potential gains and losses.
2. Simplicity: Traders do not need to manage the complexities relating to margin calls or the direct ownership of Bitcoin.
3. No Liquidation Risk: As the premium is defined up-front, all risk is pre-determined and the buyer cannot lose more than the premium paid.
Conclusion
Binary and one-touch options offer a unique and straightforward approach to trading Bitcoin, allowing traders to speculate on price movements and hedge risks with a defined risk/reward profile.
By leveraging the nature of these options, traders can navigate the volatile Bitcoin market with strategies tailored to their risk tolerance and market outlook. As the cryptocurrency market continues to mature, digital options may become an increasingly popular tool for both individual and institutional traders.
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