How Can I Use Options Trading as a Hedge for my Crypto Portfolio?
First of all: what is hedging? Hedging is a risk management strategy. If you own a significant position in a particular cryptocurrency or you do not have enough capital to own another you can use options to fence off potential losses or missed gains (it hedges you). For proper hedging strategies, you typically need derivatives, such as options.
There are multiple ways to use options to hedge. It’s an important part of an evolving finance system to have derivatives that allow you to hedge an existing portfolio or hedge future cash flows.
Power of hedging
Hedging is an extremely powerful fit with other DeFi products where you have to lock away your ETH to earn a certain amount of interest; however, upon withdrawal, you want a mechanism to manage the risk that the “ETH + interest” at a future date is worth more (or equal to) the value of your ETH when deposited in the first place. Hedgey provides the tools for such risk management.
Protecting the downside with Puts
Suppose that you have a portfolio of 10 ETH, with a current market price of $1500 / ETH. If you are concerned that the price of ETH may drop, and you plan to convert that 10 ETH into USDC (or another crypto) in the next 6 months, you could purchase a Hedgey Put contract for 10 ETH with a strike price of $1500. If the ETH price is below $1500 before expiration — you still own the right to sell that 10 ETH for $1500; hence by purchasing the Hedgey Put contract, you have effectively locked in the ETH price at $1500 for the next 6 months. You could do so by paying a premium in USDC for that right; however, you also get to participate in the upside. For example, if the ETH price in 6 months is $2,000 / ETH, you would not exercise the contract, but you still own your ETH and can sell it for $2,000 / ETH. When considering both your traditional ETH position and the Hedgey Put contract, the minimum you will get paid for your ETH is $1500 / USD. Again, this was achieved by paying a premium, yet you also continue to carry upside!
Guaranteeing the upside with Calls
On the upside, for Calls, suppose you anticipate a need to purchase 10 ETH 5 months from now to pay a contractor. You could purchase ETH now and lock in your purchase price. Suppose you don’t have the capital to purchase all 10 ETH today. You can buy a Hedgey call at $1500 that locks in your purchase price today for 5 months. So if in 5 months the price of ETH is $2,000 and you have the capital — you can purchase that ETH for $1500 to pay your contractor. If the ETH price is $1200, you will not exercise your right to buy at the strike price because ETH is cheaper; in this scenario, it’s more advantageous to purchase ETH in the open market.
The value proposition is the ability to hedge expected cash flows, or portfolio flows as part of overall risk management. In traditional markets, this is a critical component of foreign currency exchange used all the time to ensure that you can reduce your exposures — and critical for the acceptance of cryptocurrencies so that more participants can use them for real-world activities.
