We’re excited to be launching call options. Call options are a powerful instrument and can be used to hedge financial risk. A call option gives its holder the right, but not the obligation to buy an asset at the given strike price up until the given expiry date. You can learn more about call options here.
We’ll dive into some use cases and strategies for how you can use call options for hedging in DeFi:
Companies / developers / individuals who need to make ETH payments in the future
Those who need make ETH payments in the future, whether that’s to pay for gas or to simply pay others in ETH, either need to hold ETH or purchase ETH at its market price at the time of payment. In order to hedge this ETH price risk, the payer could buy an ETH call option, which would allow them to purchase ETH for a predetermined price at the time they need the ETH. This way the payer does not have to hold ETH and is not subject to market volatility if purchasing ETH at the time of payment. Additionally, they are not obligated to purchase ETH for the strike price. If the market price of ETH is less than the strike price, they can still purchase at the market price.
Market makers who want to hedge against upside volatility
Market makers aim to profit off of spreads and hedge their asset risk. ETH market makers who are trading ETH often want to hedge against large moves up or down in ETH. Put options allow for hedging against downward price movements, and now call options provide market makers the ability to hedge against these upward price movements.
Giving up upside to improve breakeven on ETH
When you sell a call option, you put down ETH as collateral and agree to sell that ETH to the option buyer for the strike price, if ETH moves above the strike price through the expiration time. This is known as a covered call. For example, if you bought ETH at $200 and sold a $260 ETH call (agreeing to sell ETH for $260), you are effectively capping your ETH upside at $60. In return for giving up potential upside, you earn premiums for selling this call option. Say your premium is $10. Then, even if ETH goes down to $190 upon the expiry of the call option you sold, you are still at “breakeven” given your premium.
Reducing the cost of long ETH protection
Individuals can also use the covered call strategy we discussed above (selling a call option with ETH as collateral) to sell upside in return for a premium, and then use that premium towards buying a put option to cheapen protection on a long ETH position. This is a strategy called a protective collar.
ETH miners who want to protect against ETH price swings
For ETH miners to reduce their exposure to ETH price swings, they could purchase put options, but they could also sell covered call options. Additionally, ETH miners could combine these actions of purchasing put options and selling call options using a collar.
Call = Put + Underlying Asset
Finally, a call is the same as buying a put and holding the underlying asset. If someone wants to get long exposure but remain hedged against downside they can either buy the underlying asset and a put or buy a call. Buying a call is one step vs two for the same end result.