Crypto Options 101 Series – Part One
An Introduction to Options
They are older than Muhammad, Jesus, and Buddha…
Yet only a minority seem to understand how they work. Let alone how to use them.
Their reputation of unlimited risk intimidates and fends off newcomers from realizing their benefits.
Which is why today we break down this wall of unwarranted fear. And in the process show you the ropes on options. Once you grasp their usefulness, you will have an edge in the market.
Their ability to reduce risk while maximizing upside means they deserve a place in your portfolio… For the rest of your trading career.
Consider this the first day of your new trading career. Let’s get started…
They are as Old as Time
You’ve most likely heard of Aristotle… For those that don’t know him, he was an average Joe who wore a toga back in ancient Greece around 350 BC.
His hangout of choice was the Agora. It’s where trendy toga wearers went to get the scoop on the town gossip.
It’s also where Aristotle most likely learned about Thales of Miletus, one of the Seven Sages of Greece, and the story of how he cornered the market.
It’s the oldest accounts of the financial derivative we are shedding some light on today… options.
It was the 6th century. Olives were the main crop. And each year after the fruit was picked, harvesters headed off to the presses.
This particular year Thales was expecting better than normal growing weather. Which in turn meant a massive harvest. And instead of just prophesying about it, Thales acted on it.
To do so, he placed a deposit on olive presses. This gave him the first right to the presses during the yearly harvest.
For Thales, it was a small price to pay to profit on his prediction. If he was incorrect and the harvest was poor then demand for the presses would also be low. Which in turn meant the deposit he placed on the presses would become worthless.
Why? Well, if you were harvesting olives during a year where crop yields were low, then you most likely have your choice of presses. In turn, press owners will most likely drop prices to earn your business.
In such a scenario, there’s no need to have a deposit on a press because demand is so low. Which means prices are ow as well. That’s why a poor harvest can make Thales deposit utterly worthless.
On the other hand, if the harvest was better than normal, presses would be in high demand. Which is what happened for our legendary options trader Thales.
The harvest was huge. Olive presses were fetching premiums and charging whatever the highest bidder offered.
The frenzy is what made Thales’ option on olive presses a cash cow. He was able to pocket the difference between what the presses normally charged and what the highest bid amount was.
It was like having the only piece of property for sale in the part of town where everybody wants to move to. He nailed his prediction.
Breaking Down the Olive Press Option
As far as what an option is, the olive press story described it in a nutshell. Every piece of the option contract was in it. Now I tried to ensure it wasn’t stale bread dry like the 52 worded opening line of Wikipedia’s page on options. Because at the end of the day the goal is to help you understand how options work, why they change in price, and when it’s appropriate to use them.
So instead of putting you to sleep, let’s go back to our folk hero Thales.
In our example Thales bought a calls option as opposed to a put option. This gives him the right to ‘call’ on the press if he wants to exercise the options contract. (We’ll cover puts at a later date.)
On the other side of this agreement is somebody who sold the contract. This person is the writer of the contract. Here it was the owner of the olive press. And when it comes to options, it’s this writer who determines a few essential components of the contract.
Here are the three essential elements of the contract from the story…
1. The first is the premium. That’s the deposit Thales must put down. This is really the cost to have the right.
2. The second is the expiration. Thales’ option was set to expire after the harvest. Which meant it wasn’t good for the following year.
3. The third is the strike price. This was the agreed upon price that Thales would pay the olive press owner if Thales decided to act on the option. Remember, the profit Thales makes on the options is the bid he receives during the time of the harvest minus the amount he pays the press owner to use the press. That amount paid to use the press is the strike price in this example, which was set when Thales originally bought the option.
So right there we just went through the main components of an options contract.
Call/Put, selling/buying, premium, expiration date, and strike. I know it’s a lot to take in, and it might feel a bit overwhelming when looking at options in the stock market or crypto market, but I assure you with a little practice this will become second nature.
For now, just focus on the olive press example… For more clarity, let’s run through it one more time.
Before the harvest, Thales bought a call option on olive presses for the upcoming harvest. He paid a premium to the press owner in order to hold this right or option contract. And in the event Thales decides to exercise the option, he will pay the press owner the previously agreed upon amount, which is the strike price.
Thus, the opportunity for Thales is to profit from the excess demand he is expecting from a massive harvest minus the amount he pays the press owner when he exercises the option.
That’s it. Now head over to Wikipedia and check out their definition, it’s almost entertaining how complicated they make it seem.
And one last note… options aren’t just for stocks or cryptos. It can be for just about anything you can think of. Of course, we are most interested in using options for our crypto portfolios. To help get you more comfortable with options, we’ll look at the crypto options chain and break it down.
Until next time, we’re on the scent…
P.s. – Did you find this article helpful? Do you want to learn more about options? Or is there something else you want to read more on? If so, please send your feedback to firstname.lastname@example.org. We want to hear from you!
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