Will Crypto Options Trading Trigger The Biggest Institutional Wave Thus Far?

The global derivatives industry in the traditional investment space is a multi-trillion dollar arena. Whether it's commodities such as gold and silver, fiat currency pairs like GBP/USD, or conventional blue-chip equities - options are a hugely beneficial asset vehicle for investors. 
Firstly, they can provide a somewhat low-risk, high-return trading strategy for investors, insofar that traders can speculate on the future price of an asset without exposing significant volumes of capital. Instead, investors are required to contribute an options ‘Premium’, much in the same way that you would put down a deposit to secure a new property development build before a single brick was laid.

Secondly, options allow traders to hedge their risk against the threats of a sudden market swing. For example, a trader that is long on the Dow Jones - but equally, fears that a bear market is potentially imminent on increased signs of a new trade war, could limit any potential down swings by purchasing put options.

As a result, it comes as no surprise to learn that options are now available in the cryptocurrency industry at both an institutional and retail investor level. With demand for other crypto-centric derivative products such as Bitcoin futures on the rise, will the introduction of crypto options take the digital currency arena to new heights?

The Evolution of Options Trading

There is often a misconception that options trading is a somewhat new breed in the investment space conjured up by sophisticated Wall Street influencers. However, this couldn't be further from the truth. In fact, while the first modern options market was launched in 1973 by the Chicago Board of Options Exchange (CBOE), the phenomenon actually traces its roots back to the 17th century.

The general consensus is that the Japanese were behind the very first fully operational options marketplace way back in 1697. Known as the Dojima Rice Exchange, the market allowed participants to buy and sell rice contracts in a formal environment.

Some historians also note that options trading played a major role during the Tulip Bulb Mania. With the underlying price of tulips driven by the modern-day equivalent of FOMO (Fear of Missing Out), it comes as no surprise to learn that a secondary derivatives market subsequently came to fruition.

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Now is the Time for Crypto Options to Shine

With institutional investors and seasoned retail traders possessing an appetite for flexible and sophisticated investment vehicles, it was only a matter of time before crypto-centric options trading also became a thing. This arguably feels like the next natural phase in an ever-growing digital currency industry that often exceeds $20 billion in daily trading volumes on Bitcoin alone.

As such, a number of notable platforms have already opened their doors to cryptocurrency derivative products that cover both futures and options trading. For example, the likes of Amsterdam-based exchange Deribit now facilitates the buying and selling of both Bitcoin and Ethereum options against the USD.

This will allow investors of all sizes to hedge their digital portfolios against the threats of a feared bear market. Similarly, traders also have the option to speculate on the future direction of Bitcoin and Ethereum in the form of an options premium.

The Deribit platform offers its options contracts as per the European-style settlement process. In other words, the platform’s cryptocurrency options are settled only when the contract expires. Moreover, the contract is settled on a cash-settlement basis as opposed to an asset transfer taking place.

Finally, and perhaps most importantly, the Deribit exchange has the necessary capacity to accomodate high frequency traders. Through its institutional-grade matching engine, not only can Deribit handle significant trade volumes, but its ultra-low latency levels operates at a rate of <1 ms. As such, this is one of the key reasons that Deribit is attracting a vast number of users from fellow crypto derivative platform BitMEX.

Institutions are Fully Catered for

It is important to take into account the relative infancy at which the cryptocurrency industry is still in. With the underlying technology itself still just 10 years old, it will of course take some time before we start seeing like-for-like crypto-derivative trading volumes, in comparison to the traditional financial scene.

However, with more and more established financial powerhouses slowly but surely entering the market, this will further amplify institutional interest in crypto-centric options trading. This was especially true in late 2017 when the Chicago Mercantile Exchange (CME) and CBOE both introduced a fully regulated market for the trading of Bitcoin futures.

In fact, the numbers speak for themselves, with the CME reporting that it facilitated close to $515 million in Bitcoin futures trades in May - representing a 250% increase from 12 months prior. Although on a much smaller scale, regulated UK-based exchange Crypto Facilities reported volumes of $84 million in May, up from just $5.2 million in January.

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The fundamental point of discussion with the introduction of a crypto-centric options market is that institutional investors do not necessarily need to be bullish on Bitcoin. On the contrary, the underlying framework of an options market also allows investors to speculate that the price will go down, without risking significant amounts of capital.

Nevertheless, irrespective of market sentiment, much like in the case of Japanese rice or Dutch tulip bulbs - where demand increases, an options marketplace will subsequently develop. However, modern day regulatory structures ensure that emerging asset classes such as Bitcoin can be strategically traded in a safe and secure eco-system.

With the foundations now firmly grounded, the markets could be ready for a significant institutional wave. While it remains to be seen how quickly the options space will accelerate institutional involvement, it is important to remember that the cryptocurrency and blockchain technology phenomenon is little over 10 years old. As such, these things often take time.

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