A derivative is a financial contract with a value that is derived from the underlying asset. In simple terms, an option on Hedgey is a derivative of the underlying crypto asset. The value of the option is directly related to the value of the crypto asset it was made for.
Options are derivatives based on the value of the underlying asset. They are financial instruments used to speculate on the rise or fall of an asset's price. People pay for the right to buy or sell an asset at a specified price before a specific expiration date.
An option contains the following components:
Strike price: The price at which you can buy the underlying asset
Premium: The option's price, for either buyer or seller
Expiration: When the option expires
Call options are financial (smart) contracts that give the owner the right, but not the obligation, to buy a certain token at a specified price before a specific expiration date. Call options let you get unlimited upside potential with limited downside risk. Calls go up when prices go up.
Put options are financial (smart) contracts that give the owner the right, but not the obligation, to sell a certain token at a specified price before a specific expiration date. Put options protect you against price drops. Puts go up when prices go down.
The owner of an option has the right to exercise the contract or not to either buy or sell the underlying asset, whereas the writer has the obligation to make good on the contract. Concretely speaking, the writer locks in the underlying asset amount of the option in the smart contract. The underlying asset amount is either unlocked by the option buyer when it is exercised or by the writer when the option expires.
The underlying asset is an investment term that refers to the real (crypto) asset that the derivative is based on.
An option premium is the current market price of an option contract. It is thus the income received by the seller (writer) of an option contract to another party.
The strike price of an option is the price at which a put or call option can be exercised. It is also known as the exercise price. The strike price is one of the two key parameters you need to take into account when considering buying or selling an option. The other is the expiration date of the option.
The relative position current price of the underlying asset vs. the strike price can be described using moneyness terminology: in the money when exercising the option would result in profit, at the money when it would result in a break-even, and out of the money when it would result in a loss.
Current price vs. strike price
In the Money for Calls. Out of the Money for puts.
At the Money (break-even)
Out of the Money for calls. In the Money for puts.
The expiration date is the last day the option is valid and can be exercised. This means that on or before the expiration date, you should have already decided what to do with your expiring option.
Every Hedgey option that can be found on the Hedgey interface is set to expire on Saturday 00:00 UTC. Convert 00:00 UTC to your local time.
The breakeven price of an option is the price at which you would breakeven if you were to exercise the contract. In other words, it is the point at which you can start making a profit. The breakeven price is always above the strike price on a call option and below the strike price on a put option due to the premium paid.
Strike Price + (Premium / Asset Amount)
Strike Price - (Premium / Asset Amount)
Example: If you buy a DOGE call option with a 1$ strike price with a 10,000 DOGE underlying asset amount for a $500 premium the breakeven price would be: 1$ + (100 / 10,000) = $1.05.
To create an option someone needs to write it. The writer sets the strike price, expiration date, and premium that needs to be paid in exchange for the right to buy or sell the underlying asset at a future price and date.
An option has an expiration date, after which the option writer can either close the position and withdraw the underlying amount or choose to roll the option.
Rolling options is the practice of creating a new option on an asset after closing one on the same asset. This can be done by option writers when the option has expired. When an option writer rolls an option, they collect the premium of the expired option and immediately enter a similar position using the Hedgey interface. The option writer has to set a new expiration date (at a minimum) but can also change all the other features of the option to sell again.
When an option is exercised, the right specified in the options contract is put into effect. In the case of a call option, it means the right to buy the underlying asset at the set strike price is exercised. In a put option, the underlying asset is sold instead of bought. Exercising the option can only be done before the option expires.
Under traditional financial options, the option buyer may exercise their option. This, however, requires the option buyer to have the cash right to buy or sell the underlying asset. This can easily make options trading inaccessible to people with small portfolio sizes.
On top of normal exercising, Hedgey leverages Automated Money Makers (AMMs) like Uniswap and PancakeSwap to automatically convert the underlying asset amount to return the profits to the option buyer and the remaining amount to the option writer. This allows option buyers to speculate and gain exposure to asset amounts exceeding their portfolio value without having to own the necessary cash or underlying asset to exercise their right to buy or sell. We also call this capital-light exercising or capital-light options trading.
Example: You buy a 2 ETH call with a $2000 strike price for $500. ETH hits $2200 and you decide to exercise your option. Instead of having to pay 2 * $2000 = $4000 and own 2 ETH you choose to cash-close your option. The 2 ETH are sold for 2 * $2200 = $4400. $400 in profit is sent to you and $4000 is sent back to the option writer. You got exposure to 2 ETH without needing $4000 to exercise it.
If you wish to exit the obligation of an option that you wrote, Hedgey will let buy back an identical option, called a closing transaction, which eliminates your short position.
Bullish: An expectation that the price of an asset is going to increase in the (near) future.
Bearish: An expectation that the price of an asset is going to decrease in the (near) future.