- Summary:
- Bitcoin investors use the options market expiry dates to predict where the spot price will head at the close of the month, but it is not all speculation.
Over the years, Bitcoin investors have used the options market expiry dates to predict where the spot price will head at the close of the month. As we approach the end of July, expect even more predictions and charts explaining how puts and calls will affect the future price of BTC as the monthly options expire on July 30.
However, the crypto options market is not all speculation. Over the past year, the options market has witnessed several innovations emerge to enhance trading, security, and overall liquidity.
The crypto market has lost over 50% of its total market value since its May all-time highs causing rumbles across the field. However, as the months go by, BTC analysts have always remained optimistic that an upcoming options expiration (usually on the last Friday of the month) will offer a different trajectory and drive Bitcoin prices upwards.
Before we dig any deeper, it is important to know what option, option trading, and the key terms are in the options market. We will then explain why the upcoming option expiry could be a major turning point for Bitcoin and the crypto market. Finally, we look at some of the innovations happening in the crypto options market and improve the traditional options trading counters.
Understanding the Bitcoin options market
An option is a contract that allows (but it’s not a requirement) an investor to buy or sell an underlying asset such as Bitcoin, real estate, oil, ETFs, etc. Buying an option that allows you to buy shares at a later time is called a “call option,” whereas buying an option that allows you to sell shares at a later time is called a “put option.”
Options are typical ‘long’ buys, meaning that you will still buy the option if you are betting on the price to rise or fall. The cost of the option is known as the “premium”, which is a fraction of the “strike price” or the price of the asset at expiry.
So why should an investor be keen on the upcoming July monthly options expiry date, and could this event impact the price of Bitcoin? With about $5 billion in open contracts set to expire at the end of the month, analysts are torn regarding its effect on the price.
Bounce, or break, that is the question pic.twitter.com/qJyyXFSIIw
— PlanB (@100trillionUSD) July 19, 2021
The max pain theory
Over the years, Bitcoin analysts have come up with the “max pain theory” to predict the asset’s price at the options market expiration date. Simply put, the theory states that the market will gravitate towards the price that offers the maximum pain to buyers of options.
Sellers causes this – usually institutions, high net worth clients, or sophisticated traders with high liquidity and capital – trying to push the price towards the max pain point by buying the asset on the spot or futures markets when the options are near the expiry date.
This ensures the maximum number of options expire worthless (i.e. buyers do not exercise their rights), meaning a maximum loss in premiums while option sellers profit the most.
In other words, buyers of the BTC option (both puts and calls) expiring on July 30 (last Friday) will suffer a maximum loss if the Bitcoin price is around $35,000. On the other hand, option sellers (writers) will try to keep the price at this level to make the highest profits.
Centralized exchanges such as Deribit (which holds over 60% of the crypto options volume) have exacerbated the narrative of “options expiry week” as a big factor influencing future prices as most of the options contracts expire at the same time (8 AM UTC).
However, Bitcoin’s price and value are affected by several factors, and focusing on the max pain point on options may not tell the full story. Moreover, Bitcoin’s options market is still relatively small for the expiry to have a sizable impact on the spot price.
Hence, having a Twitter timeline full of future BTC price predictions arising from “max pain point theory” could mislead many investors. However, the theory remains controversial, and some analysts argue whether the gravitation of price towards the max pain point is a case of market manipulation or pure chance.
Innovations in the crypto options trading market
Price theories and predictions have become prevalent during this bear market as investors clutch at straws to push the market back to its all-time highs. Nonetheless, the market has found a balance with the euphoria dying down and the BUILT lifestyle resuming – innovations and developments coming to market.
The decentralized finance (DeFi) ecosystem grew exponentially over the first half of the year as projects such as AAVE, Yearn Finance, The Graph, and decentralized exchanges including Uniswap, Sushiswap, Pancakeswap, and decentralized options markets such as Hegic and Premia entered the space.
“A revolution in the options market”
Launched in 2020, Premia Finance is one of the exchanges leading the revolution in the options market. During their short lifetime, the platform has introduced a decentralized exchange that allows users to mint their options, stake the options to earn tokens, and enhance security for buyers and sellers.
Via its innovative and decentralized structure, Premia allows users to create custom call/put options for several supported assets, including the expiration, strike price, and quantity. This opens up the field for any investor to become an options writer or buyer.
Moreover, the platform also improves participation in the options market by rewarding users who provide liquidity with incentives. Unlike the traditional options markets, which are centralized and charge high fees to clients, Premia introduces a low fee structure on the purchase of options, which all gets distributed to staking lots holders.
Finally, moving towards the decentralized options trading market could be the catalyst in calming the wild speculation around options expiry week. The ‘max pain point theory’ would fall in its tracks as it will not incentivize the option seller to manipulate the market heading into the options expiration period.