A few days ago, the CME Group announced plans to double the open spot month position for traders. Besides that, CBOE plans to launch the option for Bitcoin futures in Q1 2020. Here is a simple guide for aspiring investors.
What are Derivatives in the Crypto Market?
A derivative is a financial contract between two parties or more, whose value is derived from the underlying asset. In this instance, the underlying asset is crypto. In essence, it is an agreement to purchase a crypto asset at some point in the future at a set price. The derivative does not have any direct value. Its value is based on the expected price movements of the cryptcoin.
The main types of crypto derivatives are:
Swap
This is an arrangement between parties to exchange cash flow in the future. It is based on interest-based financial instruments such as bonds, notes, or loans as the underlying asset. Interest swaps are the most common type.
Futures
This is a contract where the buyer is under obligation to buy an asset or the seller is obliged to sell the asset at a set price in a set point in the future. Futures are important developments in crypto, due to the fact many entities that offer futures need to have valid inventory to do so. What this means is that larger financial firms need to “load up” on Bitcoin inventory to allow the offering of Bitcoin futures. In the earlier days of Bitcoin trading, no futures were really being offered in the market place. This is a positive stepping stone in the cryptocurrency environment, because it now facilitates more liquidity pouring into the market.
Options
This is a contract where a buyer has a right but not an obligation to buy an asset or sell to someone at a given price at a set point in the future.
Only a few derivatives are open to crypto investors to the young nature of the crypto market. Bitcoin futures are the most common, given that BTC is responsible for over 50% of the crypto market cap. Options trading has become quite popular in the traditional markets. Option trading started to gain traction back in 2018 when the markets were experiencing higher volatility rates. With Bitcoin historically displaying higher volatility than traditional markets, we see options potentially being a large play in Bitcoin trading. Options trading + futures in the Bitcoin space is only going to help mainstream adoption in our opinion.
Why You Should Trade in Derivatives
These instruments are quite complex and only experienced traders should use them. Here are some reasons you should educate yourself and get into the crypto derivatives market.
Volatility Protection
Derivatives exist to protect traders from the volatile nature of the crypto market. In other words, you secure the price of the underlying asset, no matter how bad the price swings get. This reduces your risk of buying the asset at a higher price.
Hedging
It is a great way to protect your investment portfolio. It entails taking measures that will offset any losses. They are an important risk management method for major investors. This is similar to having an insurance policy for your crypto assets. This way, if the crypto prices tumble, you will still have your holdings insured from any losses.
Speculation
You can also use derivatives to speculate on the price of crypto. To do this, you can simply short the price of crypto. To do this, you borrow a security from third parties and sell it in the market since you expect prices to fall. Once the prices fall, you can buy back the security that you sold. As a result, you will have settled your account with the third party and keep the profit you made.
What is Spot Market Trading?
The spot market is the most common type of market. When you visit a crypto exchange and buy and sell crypto, that is spot market trading.
Summary
Derivative trading is gaining increased attention in the crypto market. If you would like to make profits even as the prices of crypto stumble, you can still make some money.
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