Blog

February 20, 2019

An introduction on Market Making

In the crypto space a lot of people think that a market maker is a trader, or a group of traders, with a large amount of capital and a directional bias who is able to push the market around. In other words their orders or trades are so large that they are capable of moving the price significantly to suit their needs. While maybe these type of traders do exist, it’s not what a market maker is.

As the name suggests a market maker is someone who makes a market by giving buy orders and sell orders for others to trade against. They quote both sides of the market and are making money from the spread between their buy and sell price. Often they arbitrage their trade at another exchange: buy low and sell high at almost the same time. Others might be running strategies that buy and sell at a high frequency. They are mostly non directional liquidity providers. They do not necessarily care if the price goes up or down and simply want to have their bids and asks hit as many times as possible so on each trade they can make a small profit.

As you might imagine the profit per trade doing this is going to be much lower than for example swing trading large percentage moves. However the risk is also much lower (hedging where necessary). And it’s all about volume! Repeating the process many times for small but consistent gains.

Market Making on Deribit

Deribit does not have an in house trading desk. All market makers on Deribit are third parties. They are a vital part of the ecosystem as they provide liquidity around the clock on instruments that would otherwise have books too thin for many people to trade effectively.

What Market Makers Do and Don’t Get on Deribit

Much has been written about markets being manipulated on various Bitcoin exchanges. It is one of the disadvantages of non regulated exchanges; there’s no transparency and an exchange can give certain traders or desks a trading advantage. Despite Deribit not being regulated today, we can assure you no traders have any trading advantage over others.

Depending on volume, market makers may get a custom agreement on fees and help setting up. In exchange for this, and depending on what instruments they are quoting on, there will be certain rules they must follow as well. These rules will include a minimum percentage of time they must be quoting, how many instruments are covered, maximum bid/ask spreads and minimum quote sizes.

It’s also worth noting that market makers on Deribit do not get access to any insider information that isn’t available to other users, and they also do not get preferential order queuing or access to any special features/order types not available to everyone else.

Market Making on the Deribit trading engine

Deribit offers more than 100 strike price/expiry price combinations in the Bitcoin options market. Each of these has both a call and a put and each of those can be both bought or sold: we’re talking about 400 orders in the books that need to be updated every instance the Bitcoin price changes. One can imagine all these prices need to update as fast as possible by the market makers and thus needs a very responsive and robust trading engine.

Co-location

Market makers, as well as other larger traders and people using automated systems, may also choose to have their software located as close to the Deribit servers as possible. This will give their systems the lowest latency possible. While Deribit doesn’t offer any specific co-location services, the server location is displayed on the website enabling traders to install their trading software in the best possible location. This should give a latency of less than 1 ms to our servers. The server is currently located in the OVH data center SBG1 in Strasbourg, France.

Market Makers on Deribit

QCP Capital

QCP Capital is a crypto trading firm based in Singapore. Besides proprietary trading, QCP runs an OTC desk that covers spot, forwards and options 24/7.

Darius Sit, managing partner at QCP Capital: “Deribit is an ideal trading platform with a user-friendly UI that makes for efficient trading. For option trading specifically the optimal margin terms, amiable community and approachable management allows us to effectively execute our strategies.

As an OTC-focused desk we are looking forward to a feature where we would be able to cross customised contracts with our counterparties. Using Deribit as a central settlement platform would greatly benefit our options franchise business. We are also looking forward to trading options on ETH and other coins as well.”

Magpie Capital

Magpie Capital is a fund that specializes in cryptocurrency derivatives trading.

Darshan Vaidya, CIO of Magpi Capital: “This a sector that we believe still has plenty of room to grow as the market becomes more sophisticated. Whilst still in its nascent stage, we believe options can be a huge part of providing stability to existing market participants and new entrants into the space.

Deribit has been a visionary in terms of spotting this need in cryptocurrency markets at a very early stage, and is an established exchange that has proven to be dynamic, reliable, and focused on improving its user experience, for both professional firms and individual users.

As well as introducing more asset classes to trade futures and options on, we believe it’d help institutional hedgers and speculators if Deribit included a Blocking mechanism for larger trades, and the ability to trade and quote strategies of options (combinations of different outright options). Stablecoin settlement further down the road may also increase the ability to add more asset classes more easily.”

XBTO

XBTO is a world leader in digital asset trading and investing.


Philippe Bekhazi, CEO of XBTO: “We primarily develop tools and algorithms to provide high quality liquidity to the world’s digital asset markets, in spot and derivatives. We’re also an investor in the digital asset space.

Due to Deribit’s excellent technology stack, differentiated product lineup and its prudent approach to risk management, XBTO has been an early mover in providing market making flow to Deribit’s various order books.

Certain key features such as block trading and RFQ for complex option structures will be critical to increasing volumes and for furthering customer satisfaction. In the future it will be interesting to see how Deribit can evolve into a globally regulated crypto-derivatives exchange.”

Closing words

Deribit already has plans for some of these additional features in the pipeline that will make both market makers and regular traders lives much simpler, particularly for larger or multi-legged options positions. And with more currencies currently in the process of being added there will be even more instruments that need quoting in future. So there is plenty room for growth, both for Deribit itself, traders using the platform and the general Bitcoin investment space.

If you have any questions at all feel free to comment on Twitter, join our Telegram group (https://t.me/deribit) or send us an e-mail at support@deribit.com.

If you are new to Deribit you can take a look and sign up here: https://www.deribit.com/login?#/register. And for anyone wishing to try the platform out without putting any capital at risk, including any automated strategies, you can find the test site at https://test.deribit.com.

Marius Jansen – Cofounder and COO Deribit

February 15, 2019

Multi-leg Options Positions (Part 3 — Butterflies and Condors)

Cryptarbitrage

Butterflies and Condors
So far each of the positions we’ve looked at has still only had 2 legs in it. Now we’ll look at some non directional positions that have 4 different legs in one single position. First iron butterflies and then iron condors.

Before we do that it’s worth quickly mentioning that there is some disagreement about which side to label long and which to label short for iron butterflies and iron condors. The definition we will use in this article is that if the position is established for a net credit (i.e. you receive a premium for opening the whole position) then we’ll consider that selling to open the position and therefore label it the short side. Conversely if the position is established for a net debit (i.e. you pay a premium for opening the whole position) then we’ll consider that buying to open the position and therefore label it the long side.
No matter which way round you label it there is no effect on the P/L, but it’s worth being aware of when conversing with someone about iron condors and iron butterflies to make sure that you both understand which side you are talking about.

Iron Butterfly

One way to think of iron butterflies and iron condors is they are risk defined versions of straddles and strangles respectively.

You can also think of an iron butterfly as a combination of a call spread and a put spread, with the lowest strike in the call spread and the highest strike of the put spread both at strike B.

Opening a Long Iron Butterfly

  • The current price will typically be at or near strike B.
  • You are selling a put at strike A, buying a call and a put at strike B, and selling a call at strike C
  • Your risk is limited to the net debit paid to establish the position.
  • Your position will stop making gains once the price gets down to strike A or up to strike C, so your profit is also limited.
  • This position is similar to a long straddle, but you have limited your maximum profit in exchange for an overall cheaper position due to collecting some premium by selling the put at strike A and the call at strike C.
  • You are longing volatility. You want implied volatility to increase once the position is opened as it will increase the value of your position.
  • Ideally you want the price to expire either below A or above C.

Opening a Short Iron Butterfly

  • The current price will typically be at or near strike B.
  • You are buying a put at strike A, selling a call and a put at strike B, and buying a call at strike C
  • Again your risk and maximum profit are defined.
  • This position is similar to a short straddle, but you have limited your risk by purchasing the OTM options at strike A and C.
  • You are shorting volatility. You want implied volatility to decrease once the position is opened as this will decrease the value of the options you have sold. A sideways ranging market would be ideal for you.
  • Ideally you want the price to expire at strike B

Bitcoin Iron Butterfly Example
Using the spreadsheet I have constructed both a long and short iron butterfly.
The long iron butterfly consists of the following legs:
-1 put with a strike price of 3000 and price of 0.05BTC
+1 put with a strike price of 3500 and price of 0.1BTC
+1 call with a strike price of 3500 and price of 0.1BTC
-1 call with a strike price of 4000 and a price of 0.05BTC

The short iron butterfly consists of the following legs:
+1 put with a strike price of 3000 and price of 0.05BTC
-1 put with a strike price of 3500 and price of 0.1BTC
-1 call with a strike price of 3500 and price of 0.1BTC
+1 call with a strike price of 4000 and a price of 0.05BTC

The middle two options in bold are the same as the straddle from part 1, and the other two options are called the wings. These are the legs that turn it into an iron butterfly, defining the risk for sellers and profit for buyers.

This example will be left in the downloadable version of the sheet under the name ‘Iron Butterfly’.

Compared to the long straddle the long iron butterfly is considerably cheaper for the buyer meaning the max loss is lower and a much smaller move is needed to get to breakeven, the obvious trade off being that the profit in both directions is now capped.

Compared to the short straddle the short iron butterfly has the benefit of having defined the risk in both directions for the seller (in USD at least). The trade off being of course the premium collected is lower.

Here I’ve plotted the short butterfly as above (in red) and the corresponding short straddle (in blue) for visual comparison.

Iron Condor

An iron condor is very similar to an iron butterfly in that it is a combination of a call spread and a put spread, but this time they do not overlap creating a wider range. You can also think of it as a strangle with wings that define the risk (or reward for buyers).

Opening a Long Iron Condor

  • The current price will typically be between strikes B and C.
  • You are selling a put at strike A, buying a put at strike B, buying a call at strike C, and selling a call at strike D
  • Your risk is limited to the net debit paid to establish the position.
  • Your position will stop making gains once the price gets down to strike A or up to strike D, so your profit is also limited.
  • This position is similar to a long strangle, but you have limited your maximum profit in exchange for an overall cheaper position due to collecting some premium by selling the put at strike A and the call at strike D.
  • You are longing volatility. You want implied volatility to increase once the position is opened as it will increase the value of your position.
  • You want the price to expire either below A or above D.

Opening a Short Iron Condor

  • The current price will typically be between strikes B and C.
  • You are buying a put at strike A, selling a put at strike B, selling a call at strike C, and buying a call at strike D
  • Again your risk and maximum profit are defined.
  • This position is similar to a short strangle, but you have limited your risk by purchasing the options at strikes A and D.
  • You are shorting volatility. You want implied volatility to decrease once the position is opened as this will decrease the value of the position you have sold. A sideways ranging market would be ideal for you.
  • Ideally you want the price to expire between strikes B and C.

Bitcoin Iron Condor Example
Using the spreadsheet I have constructed both a long and short iron condor.
The long iron condor consists of the following legs:
-1 put with a strike price of 2500 and a price of 0.05BTC
+1 put with a strike price of 3000 and a price of 0.1BTC
+1 call with a strike price of 3500 and a price of 0.1BTC
-1 call with a strike price of 4000 and a price of 0.05BTC

The short iron condor consists of the following legs:
+1 put with a strike price of 2500 and a price of 0.05BTC
-1 put with a strike price of 3000 and a price of 0.1BTC
-1 call with a strike price of 3500 and a price of 0.1BTC
+1 call with a strike price of 4000 and a price of 0.05BTC

The middle two options in bold are a strangle, and the other two options are called the wings. These are the legs that turn it into an iron condor, defining the risk for sellers and profit for buyers.

This example will be left in the downloadable version of the sheet under the name ‘Iron Condor’.

Compared to the long strangle the long iron condor is considerably cheaper for the buyer meaning the max loss is lower and a much smaller move is needed to get to breakeven, the obvious trade off being that the profit in both directions is now capped.

Compared to the short strangle the short iron condor has the benefit of having defined the risk in both directions for the seller (in USD at least). The trade off being of course the premium collected is lower.

Constructing Butterflies and Condors Using Different Options

In the put spread section earlier we touched on how the USD P/L of a short call spread looks identical to a long put spread, and a long call spread looks identical to a short put spread. As a corollary to this it is possible to construct both butterflies and condors using solely calls, or solely puts.

I won’t go through all the permutations or it will result in unnecessary repetition, but as one example I have constructed here in the spreadsheet an example of a regular short iron condor (in blue) and a condor using only puts (in red).

As you can see in USD terms this has no effect on the P/L (the slight difference only there due to the prices I’ve chosen so you can see both lines), however it does change the shape of the BTC chart. This kind of example can sometimes be very useful when making sure your position’s payoff aligns with what you want in terms of BTC.

Next Up: Option Pricing and Implied Volatility
There are still a few other multi leg positions that skew the P/L in different directions and have their own pros and cons, essentially moving potential profit from one area of the chart to another. We’ll come back to those eventually but it’s about time we starting diving into options pricing and implied volatility, which we will do in the next article.

Before we move onto the price you manage to get for each leg of a position, everything on these profit and loss charts that we’ve been looking at so far is a trade off. If you make one part of the chart more profitable then you must sacrifice profit somewhere else, if you are willing to have higher risk in one direction, you can make a larger profit in the other etc.

I would strongly advise having a play around in the sheet by adding different combinations of options and even adding in futures longs and shorts to see what effect these have. It’s a great way to learn and will help you be able to visualise things without the need to keep referencing back to articles or websites for each position while you’re trading. This will allow you to choose the right position for your outlook on the market more easily.

If you have any questions at all feel free to comment on here, hit me up on twitter @cryptarbitrage or in the Deribit telegram chat here: https://t.me/deribit

Multi-leg Options Positions (Part 2 — Call Spreads and Put Spreads)

Cryptarbitrage

In part 1 we covered straddles and strangles, both of which had either undefined risk when selling or undefined reward when buying. We’ll now take a look at vertical spreads (call and put spreads), then bring these together to create iron butterflies and iron condors in part 3. Parts 2 and 3 together will show how you can use option combinations to define your risk and/or reward.

If you haven’t already feel free to download a copy of the position builder spreadsheet here:
[Position Builder Google Sheet]
(Go to File > Make a copy)

Call Spreads
Both call and put spreads are an easy way to take a directional trade with very well defined risk and reward. A call spread consists of 2 calls, one short and one long, each at a different strike price.

Opening a Long Call Spread (aka Bull Call Spread)

  • You are buying a call at strike price A, and selling a call at strike price B.
  • Your risk is limited to the net debit paid to establish the position.
  • Your position will stop making money once the price gets up to strike B, so your profit is also limited.
  • As the total amount paid will be less than if you had only purchased the call at strike A, your breakeven point is a little closer and you need a smaller move to be in profit.
  • You want the price to be at or above strike B at expiry.

Opening a Short Call Spread (aka Bear Call Spread)

  • You are selling a call at strike price A, and buying a call at strike price B.
  • Your risk is limited to the difference between the two strikes minus the net credit you received for the position.
  • Your maximum profit is the net credit received for the position.
  • You won’t receive as much as if you had only sold the call at strike A, but you have limited your risk substantially.
  • Ideally you want both options to expire worthless i.e. the price to be below strike A at expiry.

Bitcoin Call Spread Example
Using the spreadsheet provided I have constructed here an example of both a long call spread and a short call spread.

The long call spread contains the following options:
+1 call with a strike price of 3500 and a price of 0.1BTC
-1 call with a strike price of 4000 and a price of 0.05BTC

The short call spread contains the following options:
-1 call with a strike price of 3500 and a price of 0.1BTC
+1 call with a strike price of 4000 and a price of 0.05BTC

The long call spread here is in blue, and the short call spread is in red.

As you can see both the risk and reward are very well defined for either longing or shorting a call spread. This is particularly true when measured in USD, but we’ll cover the asymmetry of the bitcoin profit/loss properly in a future article.

This example will be left in the downloadable version of the sheet under the name ‘Call Spread’.

Put Spreads

A put spread consists of 2 puts, one short and one long, each at a different strike price.

You will notice here a similarity with call spreads. In particular that a short call spread looks identical to a long put spread, and a long call spread looks identical to a short put spread. And indeed in USD P/L terms they are basically the same thing just using different options, however they do differ when measuring the profit/loss in BTC. As mentioned though we’ll cover this difference including how to adjust for it properly in future.

Opening a Long Put Spread (aka Bear Put Spread)

  • You are buying a put at strike price B, and selling a put at strike price A.
  • Your risk is limited to the net debit paid to establish the position.
  • Your position will stop making money once the price gets down to strike A, so your profit is also limited.
  • As the total amount paid will be less than if you had only purchased the put at strike B, your breakeven point is a little closer and you need a smaller move to be in profit.
  • You want the price to be at or below strike A at expiry.

Opening a Short Put Spread (aka Bull Put Spread)

  • You are selling a put at strike price B, and buying a put at strike price A.
  • Your risk is limited to the difference between the two strikes minus the net credit you received for the position.
  • Your maximum profit is the net credit received for the position.
  • You won’t receive as much as if you had only sold the put at strike B, but you have limited your risk substantially.
  • Ideally you want both options to expire worthless i.e. the price to be above strike B at expiry.

Bitcoin Put Spread Example
Using the spreadsheet provided I have constructed here an example of both a long put spread and a short put spread.

The long put spread contains the following options:
+1 put with a strike price of 3500 and a price of 0.1BTC
-1 put with a strike price of 3000 and a price of 0.05BTC

The short put spread contains the following options:
-1 put with a strike price of 3500 and a price of 0.1BTC
+1 put with a strike price of 3000 and a price of 0.05BTC

The long put spread here is in blue, and the short put spread is in red.

As you can see both the risk and reward are very well defined for either longing or shorting a put spread. This is particularly true when measured in USD, but this time you’ll notice the Bitcoin P/L for buyer and seller diverging instead of converging like it did with the calls. Again we’ll cover the reason for this in future.

This example will be left in the downloadable version of the sheet under the name ‘Put Spread’.

On to part 3 next where we pull the positions we’ve looked at so far together to construct iron butterflies and iron condors.

If you have any questions at all feel free to comment on here, hit me up on twitter @cryptarbitrage or in the Deribit telegram chat here: https://t.me/deribit

Multi-leg Options Positions (Part 1 — Straddles and Strangles)

by: Cryptarbitrage

Multi-leg option positions allow you to build some quite unusual looking but very useful positions. You can take advantage of sideways ranging markets, trade volatility without having to choose a direction and define your risk on what would otherwise be an undefined risk position among other things.

In the previous article we covered single leg positions i.e. just a call at one strike price or just a put at one strike price. Now we’ll move on to defining some multi-leg positions with different combinations of options in them, how to construct them and what they look like in terms of profit and loss (P/L).

Before we jump into the straddles and strangles I’ve created a google sheet for building multi-leg options positions that also includes regular longs and shorts. This spreadsheet allows you to enter position combinations and then plots the profit and loss of those combined positions onto charts allowing you to visualise them immediately. It plots this in both Bitcoin and USD.

You can download a free copy here:
Position Builder Google Sheet
(In Google sheets go to File > Make a copy)
Any examples we work through in this article I will leave in the sheet so you have them ready to go and can play around with them.

Straddle Option Positions

A straddle position consists of a call and a put at the same strike price and expiry date. A long straddle is buying both the call and the put, and a short straddle is selling both the call and the put. A straddle is one of the simplest ways to take a non directional trade using options.

This is the basic structure of a straddle and how it looks on a profit/loss chart:

Opening a Long Straddle

  • The current price will typically be at or near the strike price chosen.
  • You are buying a call and a put at the same strike price and same expiry date.
  • As you’re buying two options you’re paying more premium than you would if you were picking a direction.
  • This moves your breakeven points further away from the strike price meaning you need a larger move, but of course now you have two breakeven points as you will benefit from a large move in either direction.
  • The position is fixed risk, so your maximum loss is the premium you have already paid to open the position.
  • You are longing volatility. You want implied volatility to increase once the position is opened as it will increase the value of your options. You want the price to move, the more the better, and it doesn’t matter which direction.

Opening a Short Straddle

  • The current price will typically be at or near the strike price chosen.
  • You are selling a call and a put at the same strike price and same expiry date.
  • As with a long straddle the breakeven points are moved further away from the strike price, but as you are selling this works in your favour.
  • The trade off here is that your risk is not defined in either direction, so your maximum loss is potentially unlimited. For this reason you should avoid shorting straddles until you are more comfortable with options (or you can define the risk by turning it into a butterfly position which we’ll cover in part 2)
  • You are shorting volatility. You want implied volatility to decrease once the position is opened as this will decrease the value of the options you have sold. A sideways ranging market would be ideal for you.

Bitcoin Straddle Example
Using the spreadsheet provided I have constructed here an example of a long straddle at a strike price of $3500, and also assuming a current BTC price of $3500. For this example I’ve assumed both the put and the call cost 0.1BTC each.
So this position is:
+1 call with a strike price of 3500
+1 put with a strike price of 3500

You will notice the USD profit/loss on the bottom looks exactly the same as the basic structure picture for straddles given earlier but the BTC chart looks quite skewed. This is due to the collateral and profit for the option also being paid in BTC. We’ll cover this in more detail in a separate article about the asymmetry of bitcoin profit/loss.

Now let’s add on to the same chart the sellers P/L, i.e. a short straddle with the same parameters:
-1 call with a strike price of 3500
-1 put with a strike price of 3500

The long straddle here is still in blue, with the short straddle added in red.

As a seller’s P/L is just the buyer’s P/L multiplied by minus 1, you can think of this visually as flipping the P/L around the x axis. And so as you can see the breakeven points (where the lines cross the x axis) are the same for both buyer and seller.

The above example will be left in the downloadable version of the sheet under the name ‘Straddle’. Feel free to download a copy for yourself and have a play around with the parameters.

Comparison
Let’s take a quick look at how a straddle compares to a single leg. The following is the same long straddle as above compared with just the call leg, all strikes at 3500.

With the single call (in red) you have chosen a direction so you need the BTC price to increase to profit. With the long straddle (in blue) you can now benefit from a move in either direction but the trade off is the extra premium you’ve paid for the put has dragged the whole P/L line down the chart by the amount of that extra premium, meaning you need a larger move to get to breakeven.

Any increase in the total premium paid will move the P/L line down for option buyers and up for option sellers. We will go into much more detail about this and about option pricing in general in a separate article.

As straddles are normally created with at the money options the premiums can be expensive. A cheaper way to put on a similar position is to move the strikes for the call and the put out of the money. This instead creates a strangle.

Strangle Option Positions
A strangle is very similar to a straddle in that it is non directional and consists of one call and one put, but the call and put are at different strike prices, generally both out of the money. This has the effect of lowering the premium (good for buyers, bad for sellers) and widening the range (good for sellers, bad for buyers).

Opening a Long Strangle

  • The current price will typically be between strike A and B.
  • You are buying a put at strike A, and buying a call at strike B
  • As you’re buying two options you’re paying more premium than you would if you were picking a direction, but as both options are OTM this will be cheaper than a straddle.
  • As both your options are OTM you ideally want the price to move significantly but it does not matter which direction.
  • The position is fixed risk, so your maximum loss is the premium you have already paid to open the position.
  • You are longing volatility. You want implied volatility to increase once the position is opened as it will increase the value of your options. You want the price to move, and move a lot, but it doesn’t matter which direction.

Opening a Short Straddle

  • The current price will typically be between strike A and B.
  • You are selling a put at strike A, and selling a call at strike B.
  • The range you now profit from is wider than with a straddle, however you will also receive less premium.
  • Your risk is still not defined in either direction, so although the range is wider your maximum loss is still potentially unlimited. For this reason you should avoid shorting strangles until you are more comfortable with options (or you can define the risk by turning it into a condor position which we’ll cover in part 2)
  • You are shorting volatility. You want implied volatility to decrease once the position is opened as this will decrease the value of the options you have sold. A sideways ranging market would be ideal, but you do have a little wiggle room depending on which strikes you choose.
  • If the price expires between A and B you get to keep the whole premium you received.

Bitcoin Strangle Example
Using the spreadsheet provided I have constructed here an example of both a long strangle and a short strangle . Again for ease I’ve assumed both options are priced at 0.1BTC but you can adjust the prices and strikes in the sheet to suit your needs and current conditions.

The long strangle contains the following options:
+1 put with a strike price of 3000
+1 call with a strike price of 4000

And of course the short strangle contains the following options:
-1 put with a strike price of 3000
-1 call with a strike price of 4000

This example will be left in the downloadable version of the sheet under the name ‘Strangle’. I would encourage you to have a play around with the examples as it’s a great way to learn. Change the prices, add other legs or just enter a totally different position in the second section to see how it compares to the first.

In part 2 we’ll move on to positions that use additional legs to define risk (for sellers) and define reward in exchange for cheaper positions (for buyers). This includes call spreads, put spreads, butterflies and condors.

If you have any questions at all feel free to comment on here, hit me up on twitter @cryptarbitrage or in the Deribit telegram chat here: https://t.me/deribit

February 11, 2019

Introduction to Bitcoin Options Profit/Loss

By @cryptarbitrage

This will be the first in a series of articles aimed at people new to options, and in particular the Bitcoin options on Deribit. If you already trade cryptocurrencies you are probably familiar with both spot markets and futures markets. Options however are a largely unknown product to many traders, particularly those whose first exposure to trading was cryptocurrencies. Even options on Bitcoin, by far the best known and widely traded cryptocurrency, only exist in a small number of places.

Options have a steeper learning curve than simple buying and selling which along with availability is the main reason they are underutilised. However, once you get over the initial hurdle of learning the basics they are an extremely useful instrument as you can build positions that simply aren’t possible with futures/spot. They can be used alongside futures/spot to complement existing strategies, or they can be traded in isolation.

This article won’t be going into strategy, for now we’ll just give an understanding of what call and put options are and how they work in terms of profit and loss.

First let’s get some definitions out of the way.

What Is An Options Contract?
Every option has a buyer and a seller. The buyer is buying from the seller the option to trade the underlying asset at the strike price on the expiry date.

Each option consists of the following:
Underlying asset — The asset being traded, in this case Bitcoin. (For the purpose of pricing calculations on Deribit the underlying asset is either the Deribit BTC index or the closest BTC future).
Option Type — Either a call (the right to buy at the strike price on the expiry date) or a put (the right to sell at the strike price on the expiry date).
Strike Price — The price at which the buyer has the option to buy (for calls) or sell (for puts) Bitcoin. For a call option to have value at expiry the BTC price must be higher than the strike price. For a put option to have value at expiry the BTC price must be lower than the strike price.
Expiry Date — The date at which the option is automatically exercised. After this date the option is no longer valid and can no longer be exercised.
Option Price (aka Premium) — The price the buyer pays to the seller for the option to buy (call) or sell (put) Bitcoin at the strike price on the expiry date.

The options on Deribit are European style and cash settled.

European style — Options cannot be exercised before the expiration date. However it’s worth noting that they can still be traded prior to expiry (i.e. you do not have to hold it until expiry).
Exercising an option means putting the right specified in the contract into effect i.e. buying at the strike price of a call or selling at the strike price of a put.
Cash settled — When the option is exercised any value the option has is paid from the seller to the buyer in cash (in this case Bitcoin). The Deribit options are exercised automatically on expiration so you don’t actually need to worry about how or when to do this.

Let’s look at how buying a call or buying a put compares to longing or shorting futures.

As you can see by the green lines, when buying a call or put you limit your losses to a fixed amount (unlike longing/shorting futures). In exchange for this protection you pay a premium to the option seller shifting the whole profit/loss line down the chart by the amount of the premium paid.

It’s also possible to combine more than one option to create a wide variety of different payoff curves. We will save these multi-leg positions for the next article though. For now let’s move on to the profit and loss of Bitcoin options and how to calculate it.

Bitcoin Call Option Visualisation

A BTC call option is the right but not obligation to buy 1 BTC on the expiry date at the strike price. If you are the buyer of a call option you want the BTC price to go up, as the more it goes up the more your call option is now worth.

Let’s look at an example of a call option with a premium of 0.1BTC and a strike price of $4000. The following chart shows what the profit/loss of that option would look like if you held it to expiry:

The x axis is the price of Bitcoin at expiry, the y axis is the corresponding profit of the position in BTC. Blue is the buyer’s profit/loss, red is the seller’s profit/loss. We’ll go through some examples of how to actually calculate this later.

Bitcoin Put Option Visualisation

A BTC put option is the right but not obligation to sell 1 BTC on the expiry date at the strike price. If you are the buyer of a put option you want the BTC price to go down, as the more it goes down the more your put option is now worth.

Let’s look at an example of a put option with a premium of 0.1BTC and a strike price of $4000. The following chart shows what the profit/loss of that option would look like if you held it to expiry:

The x axis is the price of Bitcoin at expiry, the y axis is the corresponding profit of the position in BTC. Blue is the buyer’s profit/loss, red is the seller’s profit/loss.

How to Calculate Profit/Loss of Bitcoin Options

If an option expires out of the money then this option expires worthless and no further transfer will occur between buyer and seller. The buyer’s only loss is the premium they paid for the option, and the seller gets to keep the premium they collected.

A call option is out of the money (OTM) when BTC Price < Strike Price
A put option is out of the money (OTM) when BTC Price > Strike Price

However if an option expires in the money (ITM), this option’s value is determined by the difference between the BTC price at expiration and the strike price according to the following formulas:

Call Example

You buy a call with the following attributes:
Strike Price: $4000
Option price: 0.1 BTC
At the time of expiry the price of Bitcoin is $5000.

Your net profit can be calculated as:
=((BTC Price — Strike Price)/BTC Price) — Option Price
=((5000–4000)/5000) — 0.1
=0.2–0.1
=0.1

So when you first purchased the call option you paid 0.1 BTC to the seller. The option was worth 0.2 BTC at expiry so you then receive this amount into your account. Leading to your net profit of 0.2–0.1 = 0.1 BTC.

Put Example

You buy a put with the following attributes:
Strike Price: $4000
Option price: 0.1 BTC
At the time of expiry the price of Bitcoin is $3000.

Your net profit can be calculated as:
=((Strike Price — BTC Price)/BTC Price) — Option Price
=((4000–3000)/3000) — 0.1
=0.3333–0.1
=0.2333

So when you first purchased the put option you paid 0.1 BTC to the seller. The option was worth 0.3333 BTC at expiry so you then receive this into your account. Leading to your net profit of 0.3333–0.1 = 0.2333 BTC.

I’ve created a free Google sheet you can use to test some more examples of options profit and loss for yourself. Feel free to save a copy for to your own drive here:
Bitcoin Option Profit/Loss Google Sheet

Maximum Profit and Loss
As you may have guessed from the profit and loss formulas, buyers of options always have a maximum loss of the premium they paid for the option. As your risk is very well defined when buying, it makes this a much safer side of the trade to be on, particularly if you’re new to options. (Though selling does have other advantages that we’ll go into in another article)

Below is the maximum profit and loss for buying and selling either puts or calls. One interesting thing worth mentioning about the Deribit options in particular is the collateral used for these options is BTC. This means your collateral gains in value as the BTC price goes up, and loses value as the BTC price goes down. This leads to a difference in how the BTC profit/loss charts look compared to how a USD profit/loss chart would look for traditional stock options.

Breakeven Points
Contrary to what is quite a common assumption with people new to options, the breakeven point is not the strike price. This would of course only be true if the option had cost nothing at all. Thankfully the calculation is quite simple, and is the same for both buyer and seller.

Breakeven for a call = Strike Price / (1 — (Option Price / 1))

Breakeven for a put = Strike Price / (1 + (Option Price / 1))

As you can see you need to account for how much you pay for the option to determine the price at which you breakeven. As a buyer the more you pay for an option the further away from the strike price your breakeven price will be, and therefore the more price needs to move for your position to make money.

Some Reasons to Trade Options
1. When buying either a call or put option your risk is fixed to the price you paid for the option, no matter how much the price moves against you. With futures/spot your risk is not fixed, and even with a stop loss in place you can’t guarantee these will execute at the price you intend. Slippage is often an issue, particularly on violent moves.
This fixed risk feature of buying options of course has the benefit that you cannot be stopped out or liquidated. It is important to note though that this is NOT true when selling options.

2. Options are much more versatile in terms of what kind of position you can build. With futures/spot you either buy or sell and the price either goes in the direction you need it to or it doesn’t. With options you can still profit from those same movements, but you can also profit from sideways markets by for example selling straddles or strangles (we’ll go into more detail about this in future articles).

3. You can trade volatility using options without having to pick the direction correctly. If IV is high and you think it’s going to fall you can short both puts and calls, if IV is low and you think it is going to increase soon you can buy both a call and a put to benefit from an increase in volatility no matter which way it goes.

4. Option sellers benefit from the markets tendency to overestimate future volatility. This means implied volatility (on average) is slightly higher than realised volatility. Sellers get to capture this difference in the extra premium they charge. We’ll go into much more detail about this in future articles as well.

It’s not all good news though. When buying options you have a time limit for your trade to work out. If you buy a call for example and by the expiry date the price still hasn’t got up to your breakeven point, that’s it the trade is over. 
If a future expires at the same price you bought it for your position will be break even (minus fees), however any options bought would have lost any extrinsic value they initially had.
When selling options your profit is limited to the premium you collected, you do not receive anything extra for being very right like you would with a futures trade.

Despite this options can be extremely useful instruments to trade in a variety of circumstances.

I wanted to keep this first article as simple as possible so we’ll save subjects like options pricing, volatility and multi leg positions for another day.

If you have any questions at all feel free to comment on here, hit me up on twitter @cryptarbitrage or in the Deribit telegram chat here: https://t.me/deribit

September 05, 2018

Stop Market Orders, Estimated Liquidation Price and more new feature

Following the introduction of the Deribit perpetual mid August 2018, we have attracted a lot of new customers from other exchanges. Some of these new customers asked for features that we were planning to add to the platform. Over the last two weeks we have prioritised a number of these requests to make our new customers feel even more at home.

Feature 1 – Stop-Market order


The first and most wanted new feature on the Deribit platform are Stop-Market orders. Deribit customers can use this order type to trigger a stop loss market order when a certain price is reached. This is a useful addition to Deribit’s Stop-Limit orders. Stop-Limit orders trigger a limit order as soon as a certain price is reached. This limit order may not be filled entirely, so user may prefer a market order instead. Both order types allow customers to choose whether the trigger price should be based on the mark price or the index. Note that the index will move faster than the mark price when prices are volatile.

Feature 2 – Estimated Liquidation price

Up until now the interface only showed the liquidation price on the positions table. Unfortunately, this is only there after a trade was executed, which confused some users. Deribit now displays the ‘Estimated Liquidation Price’ before a trade is executed. This way users can know at forehand what risks they are taking on.

The screenshot below shows the ‘Estimated Liquidation Price’ on the pre order dialog.

Feature 3 – Close Position Button and Limit close

Another new feature is the close position button. Users can access the new feature in the ‘Close’ column of the ‘Positions’ tab. Traders have the option to decide if they want to close their position at a specified limit price (gold button) or immediately at market price (red button).

Feature 4 – ROI / Return on Investment

Lastly, Deribit introduces the Return on Investment display on its trading platform which shows the ROI percentage value of open positions. The ROI percentage is calculated with the following formula: ROI = (100% * PnL)/(Initial Margin). The ROI adjusts in real time. This allows customers to easily determine and compare the current state of a trade.

Going forward

For now we are focusing on adding other crypto’s to the platform which we expect to finish within a few weeks.

We are also working on more improvements to the interface, as well as smaller features. If there are any other requests don’t hesitate to ask engage us on Telegram or Twitter. Either you will speak directly to management or we will hear about it.

August 28, 2018

Deribit Perpetual comes out of Beta with 100x Leverage

Deribit PerpetualOn the 14th of August we launched the beta version of our substantially improved version of the prominent Perpetual Swap; the Deribit Perpetual.

In the two weeks since the Perpetual beta was launched, it quickly became the dominant product on the Deribit platform. Thanks to the Perpetual, total volume on the exchange went up by more than 50%. Market makers have also shown an increasing level of support. As a result the Deribit Perpetual trading book has developed into one of the most liquid books in the market with significant size on the bid and offer side.

The Deribit Perpetual provides traders with:

  • Low Fees: Charging just 0.075% on market orders, paying 0.025% on limit orders
  • Extremely fast trading: Executing transactions in a few milliseconds
  • Overload Protection: A flexible system able to deal with any volume
  • Price Stability: Continuous payments and other measures keep the Perpetual’s price close to the Bitcoin price
  • Fair Liquidation: The closing out of a leveraged trade does not hurt more than it has to.

As from today the Perpetual also provides traders with 100x leverage.

100x Leverage

We are now comfortable to increase the maximum leverage to 100x. This means that for every USD in the account (minus the trading fees) you can take USD 100 of exposure.

Liquidation Fees Increased by 0.05%

Deribit tries to make liquidations of leveraged positions as painless as possible. We do this by using step-wise, incremental liquidations in combination with crediting any funds left over after a (partial) liquidation back to the traders. In most cases this brings a position back in line or at least returns some funds to the customer. Our competitors will liquidate the position in one go and not return any left-over funds.

Deribit does charge an additional ‘liquidation fee’ to compensate its reserve fund in the case of a liquidation transaction. As of today this liquidation fee will be increased from 0.10% to 0.15%. We expect this fee increase to cover any additional risks and will allow our reserve fund to continue to grow at a modest pace.

Cross-Margin vs Isolated Margin

Deribit works with “cross-margin” and this means the funds in the account serve to back all outstanding trades. If you want to use isolated margin and apply a certain leverage to a single trade you can use a sub account to isolate the required margin for the trade.

August 14, 2018

Introducing The Deribit Perpetual

Deribit perpetual betaToday Deribit launched a blazing fast version of the extremely popular Perpetual Swap. We are launching this product in Beta, but it is fully tradable. We expect to come out of Beta and add some additional features soon.

The Perpetual is responsible for between 40 and 50 percent of all global trading in Bitcoin. It allows traders to take positions without any bitcoin actually changing any hands. It features low fees and traders can take very high levels of leverage. This means traders can take very large positions with only a small capital outlay.

A Perpetual is a complex product for an exchange to implement. Up till now the only exchange offering it was BitMEX. Thanks to the Perpetual, this exchange is currently the dominant one globally.

Deribit now offers a version that has a number of large advantages over the conventional product.

Blazing fast execution

Deribit already had one of the most advanced platforms in the market. Over the last half year Deribit’s developers worked flat out to make sure that our order execution speed will remain blazing fast even under extremely high volumes. This means Deribit can handle thousands of order requests per second. Even then, order delays wil be at most a couple of milliseconds per order.

The Deribit Perpetual executes orders 20x to 40x faster than the conventional Perpetual on average, and in fast moving markets the difference can be significantly larger. Fast execution can have a significant positive effect on profits, especially in the case of large price moves. It also provides our customers with comfort that there are no preferred parties that are allowed to front run the market.

Continuous pricing

In order to keep its price close to the Bitcoin price, a Perpetual uses so called ‘funding payments’ that occur between the buyers and sellers of the contract. The conventional Perpetual transfers the funding payment every 8 hours and this can cause bumps in the contract price around the moment of payment. The Deribit Perpetual makes tiny payments on a microsecond basis. This completely avoids price disturbances and will serve to keep the Perpetual price very close to the Bitcoin level.

Fair Liquidations

Perpetuals and related products like futures enable traders to take large ‘leveraged’ positions on the basis of only a very limited amount of capital. The capital backing a leveraged trade is called ‘margin’. At the moment Deribit offers 50x leverage so with 1 Bitcoin of margin you can take a 50 Bitcoin position. If the price moves against a leveraged position, eventually the exchange has to close out (liquidate) the position in the market to ensure there is always enough capital to cover the potential losses of the trade.

A number of high profile liquidation related incidents at other exchanges have resulted in large losses for traders. Deribit has designed a fairer liquidation mechanism that executes liquidations on an incremental basis while continuously trying to bring the position back into compliance. If a position is eventually closed out Deribit customers retain any capital that is left over instead of automatically losing their entire margin.

In most cases Deribit is able to stop the entire position from being liquidated or return some of the margin to the customer. Deribit has never had to ‘socialise’ liquidation losses by recouping them from other traders.

Another important advantage of Deribit over other exchanges is that they allow unrealized profits to be used as capital. This means that if a position is profitable, the unrealised profits can be used immediately as capital to open new positions, without waiting for a settlement.

Perpetual Improvement!

The Deribit Perpetual will be in beta initially. We expect it to come out of beta soon with some interesting new features. Other crypto currencies like ETH and BCH will follow pretty soon.

If you have any questions don’t hesitate to contact us on support@deribit.com or join our conversation on twitter or Telegram

For a more technical explanation about the Deribit Perpetual, see our documentation

About Deribit

Deribit was founded by John Jansen, an early crypto investor with a background in options trading on the Amsterdam Options Exchange. In 2014, after a period trading cryptos on different exchanges, he developed a vision of an exchange where it would be possible to trade Futures, Options and other ‘derivative’ products in a secure – high performance – environment. John then proceeded to team up with a group of technical experts to turn this vision into a reality.

After two years of intensive development Deribit went live on June of 2016. Currently Deribit is a top 3 crypto futures exchange and the number one crypto options exchanges globally. We run our business from our office in Amsterdam (The Netherlands) and our development team is located in Poland.

About Perpetuals

A Perpetual on (for example) Bitcoin is a product that aims to closely track the Bitcoin price. It is based on the underlying price of Bitcoin without any real Bitcoins being involved. This makes the product a so called ‘derivative’ product. This means that traders enter into ‘contracts’ with the exchange instead of doing an actual Bitcoin transaction.

In these contracts Perpetual traders pay or receive the difference between the price when they entered into the position and the price when they unwind it. So if the price level of the Perpetual was USD 7500 when someone bought a position and USD 8000 when they sold it the payout is USD 500 worth of Bitcoin for every Bitcoin of exposure.

Traders can buy contracts – called long positions – that benefit from a rise in the price. Conversely, traders can sell contracts – called short positions – that benefit from a price decline. There are always as many long as short positions outstanding, so the exchange has no position itself.

The product is makes it very easy to quickly trade in and out of both long and short positions and features low trading fees. Perpetuals also allow for high leverage. This means that for every single Dollar of collateral in the account a trader can take up to 100 Dollar of Bitcoin exposure.

The product is related to the futures contract but unlike a futures contract a Perpetual does not have a finite term and that is where its name comes from. The price of the Perpetual is kept close to the Bitcoin price by funding payments between the longs and the shorts.

If the Perpetual trades higher than the Index, traders that are long the perpetual need to make funding payments to the shorts. This will make the product less attractive to longs and more attractive to shorts and this will serve to push the Perpetual price back down to the level of the Index. If the Perpetual trades lower than the index the shorts will have to pay the longs.

August 10, 2018

Deribit Introduces Sub Accounts

After our big upgrade last Thursday we promised you a lot of new features and products in the coming period. Today we would like to present the first new feature: Sub Accounts.

Sub accounts allow for the separation of a portion of a trading account, both administratively and from a margining perspective. Every account can generate a maximum of 4 sub accounts that allow for the implementation of managed accounts and dedicated margin for certain trades or strategies.

Managed Accounts Possible

The sub accounts allow for the creation of separate login data but the sub account login does not give any right to withdraw funds. This means a manager or adviser could get access to a sub account and execute trades on behalf of the client without being able to withdraw funds or access the main account.

Isolated Margining of Trades and Strategies

Normally all positions in a Deribit account are cross-margined, this means that there is one pool of available margin for all positions and one sufficiently large liquidation could have a big impact. Sub accounts are individually margined so they can be used to allocate a certain amount of margin to a given trade or strategy.

Say for example that a trader wants to put on a risky trade or a new bot-based strategy; both of them should not impact the total amount of margin if they go wrong. These risky trades or strategies could be assigned to separate sub-accounts protecting the margin in the rest of the account.

Users can instantly transfer funds between the main account and sub accounts. This means margin can be increased and decreased at a moment’s notice.

Here is a video from our co-founder Marius made in order to explain this new functionality:

Stay tuned for even more upcoming products and features that the market has been asking for.

August 09, 2018

Deribit Finishes Massive Infrastructure Upgrade

For more than half a year our development team has been working to drastically change the architecture of our trading platform. The goal was create a platform that is really built to scale, potentially to millions of users. This project was the reason our customers have been waiting for the introduction of new trading products for some time. Yesterday we have executed a massive upgrade, completing our work on scalability. After this upgrade we will start adding new products and features at high speed.
Like with any large upgrade it is possible that the system encounters some problems over the next few days. If this happens we want you to know that we will try our best to ensure any degraded service will be kept to a minimum. If you encounter any issues, please don’t hesitate to contact support.

Background of the upgrade

Deribit used to have quite a traditional architecture where all activities related to a trading book were dealt with on the same server. As we have seen with a number of other exchanges, not properly taking scalability into account can lead to a lot of performance problems down the line. As Deribit intends to drastically increase its scale and does not want to make any concession to its blazing fast execution we needed to solve this problem first.
After this upgrade our exchange runs on a large cluster of dedicated servers, where the matching engines are running on servers isolated from the rest of the internet. The matching engine servers do all the matching and order handling for the trading books. They continuously send out order state updates to the webservers to which all users connect. The webservers do all the work needed to inform the customers about the status of their orders.

The new architecture is extremely flexible. For each matching engine server we can quickly launch an almost unlimited amount of webservers to which traders can connect. At the same time the webservers are kept completely in the loop of the state of the matching engine. This happens in such a way that if a problem would appear on the matching engine server, a web server can easily be converted to become a matching engine server.

This means that we do not even need specific backup servers anymore, as all our webservers are effectively stand-by replacements. Thanks to this new setup, we can now handle a virtually unlimited amount of messages and requests. The matching engine is now also extremely efficient and only has to deal with trade matching, and adding or removing orders from the order books.

Now our platform is ready to deal with any volume, stay tuned because over the next few days we intend to release a number of products and features that the market has been loudly asking for.

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