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Ep: 36 How to use options to hedge against volatility
Use Options to hedge.
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TLDR below. This is not financial advice.
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What are Options?
Options is an obligation to do something. You can also limit your risk with this contract. The general idea is that options are really just a bet to do something or an alternative to do something.
Literally it means the option to buy or sell an asset at a specific price by a specific date.
So if you have a paper and you sign on a paper and then you have to choose four things:
I want to Buy (action)
I choose the $LISA (asset)
At a price of maybe 2 bitcoins (strike price)
By the 15th of January (expiry)
It's kind of like when you're young and you make a promise with your best friend saying that if you’re both single by 40 then you’re going to consider marrying each other. So you make a promise with each other and at that date (40 years old) or the options expiry date and you can choose whether to execute the contract.
By the time you're 40, you and your friend can say that yes we get married or no we don't get married. That is really just an option or a promise to do something. You don't have to do but if the contract buyer agrees then it will be done. Because of that you have to pay for it because this agreement is valuable because if both parties agree to execute it then there is value in that. Options are not free and you have to pay some money for it.
Put vs Sell
Generally, there are just two types of options a call and a put so a call is to buy the option and a put is to sell the option. Let's say I want to buy $LISA at one bitcoin then I have a call option there so I want to buy it at this specific price then that is the agreement that we have. Or you want to sell $LISA at a specific price then that is the put option.
Holding Underlying vs Buying Option
If the options are to buy or sell the asset then what's the difference between me just holding the underlying asset instead? Why do I have to buy an option to buy or sell the asset when I can just hold the underlying asset?
Stack strategies: It gives you more varieties to play around with strategies so if you are doing trading or if you're doing a lot of different complicated strategies then options might be a better alternative because it gives you more variety and more leeway to play around and strategize.
Lower cost/risk: In financial terms, options are sometimes much better alternative. For example if you were holding the underlying asset then your losses could be unlimited because you could lose the entire underlying asset whereas if you're buying an option the losses can be limited depending on what kind of options you're looking at so in that financial aspect options can be a bit safer
Less capital lock-up: The other reason you want to buy options versus holding the underlying asset is that with buying options there's slightly less upfront amount of money to be paid so let's say options cost two dollars per option contract and depending on the strategy you're looking at then the maximum loss is that two dollars and also the amount of money you're putting upfront are that two dollars until you're willing to execute the contract so in that sense it's it could be friendlier in terms of of the financial aspects
What Else Did You Miss?
How to read Options
Options as Insurance against Volatility
Traditional finance VS DeFi in terms of options
What needs to be done?
The Black-Scholes Formulas
Why do people buy options?
Listen on podcast if you prefer audio version.
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Options sound complicated but when you know why you are using them, it's easier to make sense of them. Options are a promise by someone to sell or buy an asset at a specific price at a specific date. You pay to get that promise. You can use it to hedge against price volatility or to speculate in the market.
Get smart: Put options as insurance for price dropping. Call option if you think prices are going up.
Get smarter: Nothing is free. Watch out for prices of the option contract. You might not breakeven if the prices don't move much.
Ps: Order the textbook "Economics and Math of Token Engineering and DeFi" today!