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EP41 Three Simple Options Strategies as DeFi Insurance
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TLDR below. This is not financial advice.
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One of the most attractive features of options is that it can be a combination of options or combined with other derivatives to create a variety of strategies. The possibilities for profit can be so varied that almost any investor can find a strategy that meets their preferred level of risk and is in line with the market forecast.
Without options, the strategies are very limited. If the assets are expected to increase, people would buy the stocks; if they are expected to decrease, people would sell them. Choice makes the move from forecasting to a profitable action plan if the forecast is correct. Of course, the strategy will punish you for incorrect prediction. However, with the correct use of options, the punishment will be quite small and predictable.
In this newsletter, we will introduce some simple options strategies that you can apply easily. These strategies are the easiest to understand and require the least transaction.
Covered Call Option strategy
TLDR: I have $ETH. I sell options for $ETH so people can buy $ETH when prices increase. I get money upfront. I lose the infinite upside.
Who will use this strategy?
You have people who own the asset, say $ETH. In the crypto space, we have two types of people. The first type is people who just have $ETH as an investment and keep it in their wallets. I'm looking at you, institutional investors.
The second type is people who are liquidity providers to protocols like HEGIC, OPYN.
Sell Call Option
For people who are liquidity providers, this is where you will be selling a call option.
Crash course: call option is basically the ability for someone else to buy your ETH. You're selling the possibility for someone to buy this asset (ETH) from you at a different price.
Let's say ETH right now is worth $1.800 and you want to sell this call option. The strike price is $1.950 and they have to pay a premium of $100. Let's say ETH becomes $2.200.
Because someone bought the call option from you, they can go to you and buy at $1950 because you've already made a promise. The benefit for you is that you received this $100 premium no matter what. This premium is why people want to be option sellers as they get to earn some money.
How does this strategy help to manage risk?
This is money upfront whether ETH goes to $2.200 or ETH drops to $1.000. Whatever happens to ETH doesn't matter because I have this $100 upfront.
Married PUT (Options insurance)
TLDR: I have $ETH. I am worried about $ETH price falling. I buy put option as an insurance. I lose the cost of options (aka I lose the payment for insurance). I gain all the upside.
Married PUT is protection against prices falling. You have an asset (ETH) and you buy a put option.
Let's say ETH is $1800 and you buy a put option, which means that someone will buy the option from you at a specific price of let's say $1800 so that there is no volatility in prices.
Again your option premium is $100, your maximum cost. Your maximum gain is when $1800 goes very high and you can sell it and have maximum gain and if $1800 falls to $1600 then you can sell your ETH at $1800. You make the difference which is $200 minus your cost of $100. This is how you can use put options as a strategy to help you against prices falling.
Who uses Married PUT?
Married PUT will be used by people:
Using ETH for trading
Holding ETH and worried about price fluctuation
Protecting assets at a specific monetary value
Bull Call Spread
TLDR: I am super bullish. This is going to the moon. I buy options at a lower price (so I get to buy it cheap). And I sell options at a higher price (so I can use the funds to pay for buying call options).
What we're trying to do is to limit the losses and increase the returns within the range.
Strategy one is really helping you to earn some money between the two different prices and a range. But you can also have a downside because if prices increase too much, then you would be bearing a huge loss. If ETH becomes $10,000 and you have to sell them at $1950 then you're making a huge loss.
What you do with the Bull Call Spread is that you're buying a call option and you're selling a call option at different prices. So an extension to strategy one.
To construct this bull call spread we need a few things the first one is you're going to buy and sell call options during the same transaction so let’s say ETH is $1800 and buy call options at $1700 and you sell a call option at a higher price of $1950 so what this strategy does is basically to limit your losses and also limit a bit of your gain but you get to earn the premium in between the two prices so for this to work you need three strategies:
What do you need
The same quantity of ETH
Same ETH asset so you can't have one ETH and one BTC as it doesn't work and this is used to protect the same asset
The expiry is the same so they both expire at the same time
The key difference between strategy one and strategy two is that it makes more sense if you actually own the underlying asset. In this situation, it might not be the case when you actually have to own the underlying asset because when you're buying and selling the call option you kind of cancels them out.
Listen on podcast if you prefer audio version.
Strategies are presented here to create basic positions from which you can explore other new strategies. As mentioned, options strategies allow the creation of positions with the risk aversion level from the investor's demands. Using the strategy as a hedge, it is necessary to consider whether your position is suitable or not.
Get smarter: Not any asset has options based on it. However, we can design our own to make contracts that closely resembles an asset we hold with another asset. Of course, the complexity and number of transactions also increase, they reduce profit by cost.
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