As you might know, there are different ways to get exposure to cryptocurrencies. We got used to spot trading in 2016 and 2017. However, as new investors, traders and experts continued entering the market in recent years, there has been an evolution in the trading tools offered by crypto exchanges.
Nowadays, we find in the market different investment solutions such as margin trading, crypto futures, and options trading. Each of them is different and fits different strategies from investors.
In this guide, we are going to share with you the differences there are across these trading solutions. You will notice that there is no “killer” option but they all would have pros and cons.
What is Margin Trading?
Margin trading involves borrowing funds from other parties in the market to get a larger exposure to a specific asset. Funds are usually borrowed by investors from brokers. In the cryptocurrency market, several traders want to increase their exposure to specific digital assets. In order to do so, they borrow funds from the cryptocurrency exchange they use.
So as to trade with borrowed money, traders should use collateral. The collateral can be the whole amount of funds held by the trader on his account or just a portion of it. These funds are going to be used to keep the position open in the market. In this way, the lender can be sure he will receive the funds back if there is a trade that moves in the contrary direction the investor thought.
Cryptocurrency exchanges are now offering leverage of up to 125x. In this way, traders can purchase virtual currencies with 125 times more money than what they have as collateral.
Let’s use an example, if you have $1,000, you can trade with 20x leverage. This would allow you to open a position for $20,000. If the position closes at a 5% profit, you will receive 5% calculated on $20,000 rather than on $1,000. In this way, you made $1,000 in profits (you doubled your funds).
Remember you should also pay a small trading fee and the interest rates for borrowing the funds. Thus, your $1,000 in profits will be closer to $950.
Pros of Margin Trading
- Users can get large exposure to cryptocurrencies
- Profits could be massive
- Traders get the chance to trade derivatives
- Investors can trade with as much as 125 times their collateral
- It is possible to open short positions trading contracts
Cons of Margin Trading
- It is extremely risky
- Several traders lost a lot of money
What is Futures Trading?
Futures trading makes reference to a type of derivatives in which parties are obligated to buy or sell an asset at a predetermined price and at a pre-established date in the future. This type of practice became very popular in the crypto market in recent years.
In the cryptocurrency market, rather than trading the underlying asset (Bitcoin or another virtual currency), investors trade contracts. Perpetual contracts are the most popular ones. Perpetual contracts do not have an expiry date or a determined price at which the buyer or seller must transact it. Thus, they are very flexible and closely follow the spot market price.
By trading futures, traders could open short or long positions in the market. When trading in the spot market, investors can only make money if they buy an asset. However, when trading futures, traders can make money even if the price of the asset moves downwards.
Pros of Futures Trading
- Investors can open both long and short positions
- It is possible to use leverage with contracts
- They are very liquid (in some cases more than the spot market)
- It could be a way for traditional investors to gain exposure to digital assets
Cons of Futures Trading
- Traders do not handle the underlying asset
- They might not be easy to understand for beginners
What is Options Trading
Like futures, options are derivatives that refer to contracts that give investors the right to buy or sell an asset at a predetermined price and date in the future. Compared to futures where traders have an obligation to execute the order, options do not require the investor to execute the contract.
Thus, the term option derives from the possibility the trader has to decide whether or not to sell the contract. Options trading is usually used to reduce the risk on some positions and also to speculate with price fluctuations of assets.
Investors would be able to hold both call and put options. The call option involves buying an asset in the future (it is not an obligation). A put option, instead, allows the owner to sell a specific asset once maturity has been reached. In some cases, the options can be sold and purchased before they expire.
Pros of Options Trading
- Offer a different way for investors to hedge against price fluctuations
- Investors could use them to speculate with price movements of underlying assets
- They are less risky than fixed-term futures
Cons of Options Trading
- They are usually less liquid than other contracts
- They are not widely available in the crypto market
Margin vs Futures
Main Differences
As we have mentioned before, margin trading makes reference to borrowing funds from a broker or exchange in order to get larger exposure to a specific trade or asset. Instead, futures are biding contracts that obligate the investor to buy or sell an asset at a specific date in the future and for a predetermined price.
Which One is Easier?
It is usually easier to trade futures, but more specifically, perpetual contracts. They are very similar to spot trading. Indeed, if you do not use margin, then it will be almost the same as trading in the spot market. The main difference would be related to the fact that you are trading contracts and not the underlying asset.
Trading with margin requires you to use part of your money as collateral to borrow funds. If the price of the underlying asset moves in the right direction, then you will make the profits taking into consideration the funds borrowed.
Margin trading might be somehow complicated to understand for newcomers. Expert traders usually trade with margin. Moreover, this is very risky.
Which One Can be More Profitable?
Clearly, trading with margin would provide you with larger potential profits. Nonetheless, this also comes at a higher risk of losing not a portion of your money but all your funds. Furthermore, when you trade futures contracts with margin, you are using both types of trading.
In our previous example, we have seen that with a $1,000 position and 20x leverage, users could trade with as much as $20,000 and get the profits on the $20,000 rather than on $1,000.
Risks
There are many risks involved in margin and futures trading. The main and largest risk of margin trading is related to losing all your collateral. If the position you open gets liquidated (it means that the collateral was used to re-pay the loan), you lose all your funds.
When trading futures, the main risk is related to the settlement price. If you purchased a futures contract at a determined price and the expiry date arrives, you would like to execute that order at a profit. If the asset you purchased is now being traded at a lower price, then you could have bought it cheaper. Nevertheless, you hedged your risk.
Futures vs Options
Main Differences
The main difference between futures and options relies on the fact that futures are binding contracts in which you are obligated to buy or sell an asset at a predetermined price once maturity is reached. Instead, with options, you are not obligated to do so. You can, but you might not execute this right.
Which One is Easier?
There is no clear answer to this question. Indeed, both of these instruments are pretended for advanced traders that want to hedge their risk when trading cryptocurrencies.
While futures obligate you to execute the order at maturity, options give you the freedom to decide whether or not to do so. Taking that into consideration, they have a similar level of difficulty. Everything depends on the situation you are in and the goal you want to achieve.
Which One Can be More Profitable?
Futures are usually more profitable than options due to the increased leverage users enjoy in different cryptocurrency exchanges. As we previously explained, some platforms are already offering traders the possibility to trade with as much as 125x on some trading pairs.
Nevertheless, this also riskier. You might lose your collateral and get liquidated.
Risks
When trading futures, the risk you have is that if you used leverage, you would get liquidated and lose your funds. When trading options your upside potential is also very high, but the risk is reduced. You could only lose as much as you paid for the option.
Thus, futures trading involves leverage risk while options trading could be affected by price fluctuations (if an asset moves to zero you lose all your investment).
Options vs Margin
Main Differences
Margin trading is an activity by which investors borrow funds to increase their trade positions. Options trading is a way not only to hedge against possible price fluctuations but also to speculate in the market.
Margin traders usually use perpetual futures contracts that have no predetermined maturity date and their price follows very closely the spot market. Instead, options traders would have the possibility to buy or sell an asset at a predetermined date in the future and for a fixed price.
Thus, the main difference lies in the type of contract you are handling and the details of these two contracts.
Which One is Easier?
If you are trading perpetual contracts using margin, then it could be very easy. Even though, this is an activity that is usually performed very consciously by expert traders. Newcomers might have some confusion in terms of understanding options and futures. This is why it might be easier to trade with margin.
Nevertheless, each of these trading methods has its own challenges. Traders should properly understand the risks and details of these two trading tools. Depending on your needs and the goal you want to achieve you would use one or the other.
Which One Can be More Profitable?
Margin trading could be certainly profitable. Indeed, the possibilities are very large. By opening a winning position with large leverage and collateral, you could register extremely profitable trades.
Options trading is also profitable. This is certainly a fact. However, the profits are potentiated with margin trading. Thus, everything will depend on whether you use margin or not. The larger your position and exposure to a winning trade, the more profitable it becomes.
Risks
Of course, as we mentioned before, there are risks involved in trading. This is why it is certainly important to manage risk. When you trade with margin, you can lose your margin and you will also have to pay for the commissions and fees related to the trades and borrowed funds. The lower the leverage, the lower the risk you have when trading with margin. The higher the leverage, the higher the probabilities of being liquidated.
When you trade options, the asset that you are trading could lose value. If the asset goes to zero (meaning that it lost all its value, which is extremely rare), you would lose all your funds. However, most of the traders close their positions at a loss to avoid losing even more.
Conclusion
Depending on your skill, budget, and experience you would choose one or another trading tool. Expert traders use a combination of these types of trades in order to reduce losses and increase profits.
Different crypto trading strategies require different contracts and assets and clear risk management. If you do not want to use large leverage, you can start with 2x or 5x. Moreover, if you prefer to avoid futures you can perhaps use options that do not obligate you to execute your right.
All these are just some trading tools you have to improve your cryptocurrency trading skills and register profits.