How Perpetual Options are Picking up Pace

Summary:

A perpetual option is an exotic option that has no exercise limitation and no fixed maturity. These options are also called expirationless options or non-expiring options and are traded in the OTC market. This blog details how the regular trader can navigate their way through perpetual options.

Introduction to perpetual option

A perpetual option (XPO) is an exotic option that has no exercise limitation and no fixed maturity. For a regular option, the lifetime is usually between a few days and many years, but in the case of perpetual options, it has provisions to be exercised at any time and does not come with an expiration date. These options are also called expirationless options or non-expiring options.

Usually, these options are not traded or listed anywhere. When they are traded, it takes place in the OTC market. The pricing behind perpetual options is still undecided and studies are still ongoing to determine how it could be achieved. Even though they are non-standard options, some investors go to the extent of calling them plain vanilla options because they are just like any other options, except for the only distinction of no expiry date.

How perpetual options work

Perpetual options, also called perpetual swaps or perpetual contracts, are a kind of financial derivative that closely resembles regular options but have some prominent differences. These options are usually associated with cryptocurrency exchanges and trading and are a popular instrument for trading digital assets.

The following is a list of the features and characteristics of perpetual options:

1. No expiration date: In contrast to regular options, which have specified expiration dates, these options do not have a fixed expiration date. In fact, they are designed and made to be held indefinitely, enabling investors to enter and exit positions at their discretion.
2. Continuous trading: Perpetual options have provisions for continuous trading, throughout the day, all through the week, which is just like the spot trading of cryptocurrencies. This continuous trading is enabled through the mechanism called funding rate. This ensures that the price of the perpetual option closely tracks the spot price of the underlying asset.
3. Funding rates: Perpetual options utilise funding rates. These are periodic payments exchanged between long and short positions so that the price of the option can be kept in line with the underlying asset's spot price. Usually, the funding rates are settled after every few hours, or sometimes minutes, and can make it lucrative for traders to balance their positions through long and short calls.
4. Leverage: Traders have the liberty to use leverage when trading perpetual options. This allows them to have control over a larger position despite using small capital. This can result in both potential profits and losses.
5. Settlement mechanism: In contrast to traditional options, which can be settled physically (where the underlying asset is delivered) or settled for cash (where the difference in value is paid), perpetual options are usually settled in cash. The profits and losses are finalised in the contract's base currency.
6. Liquidity: These options often have higher liquidity in comparison to traditional options because they are continuously being traded and are extremely popular on cryptocurrency exchanges.
7. Risk: Trading in perpetual options has the probability of being very risky because of the possibilities of large price swings and leverage. Investors and traders run the risk of losing their initial investments if by chance the market moves against them.

These options are a relatively new financial instrument and are primarily associated with cryptocurrency trading platforms such as BitMEX and Binance. They have not been standardised like traditional options and the terms and conditions can differ depending on the various exchanges and platforms where they are being traded.

Why perpetual options are unique:

With an option contract, the holder has the right, and is not obliged, to buy (call option) or offer for sale (put option), a certain amount of an underlying security for a price that has been decided earlier, or before the expiry of the option. All this holds true for a perpetual option as well. The only difference is that there is no expiration date.

Another distinction that sets perpetual options apart is that the traditional trader is not likely to come across these options. Determining and allocating a value is complex and difficult, and the trader who holds the option will be constantly exposed to risk as long as the option remains open.

Summing up

Perpetual options are affected by market volatility and liquidation risks. Investors need to exercise caution because these financial derivates are mostly unregulated and carry an element of risk. With a little help from the right sources and the details listed in this blog, you should be able to diversify your portfolio using perpetual options.