Trader's Advanced Course: Mastering DeFi Options Strategies
Investors can execute unlimited strategies through options.Author: Chain to Blockchain
What are Options?
Options are a type of derivative contract that gives the buyer the right, but not the obligation, to buy or sell a fixed quantity of an underlying asset at a fixed price on or before a specific date (commonly referred to as the expiration date).
In DeFi, the underlying assets can actually include any ERC-20 asset, such as: WETH, WBTC, UNI, YFI, SNX, and so on.
In traditional finance, investors use options for various reasons. This may include generating income, speculation, and hedging positions in their portfolios. Ultimately, options serve as a reliable tool that allows investors to take more sophisticated and expressive positions in the market, thereby better optimizing the risk in their portfolios.
Next, we will focus on intermediate and advanced options strategies that utilize capital efficiency (such as spreads). Spreads allow long options to collateralize short options, enabling users to use the maximum loss of the structure as collateral.
A Brief Introduction to Opyn V2
Opyn v2 is built on the Gamma protocol and is a DeFi options trading protocol that allows users to buy, sell, and create options on ERC 20. DeFi users and products rely on Opyn's smart contracts and interfaces to hedge DeFi risks or speculate on different cryptocurrencies.
Opyn has 7 distinct differences from other DeFi options protocols:
Allows for more capital-efficient options trading strategies, such as spreads
Enables rapid minting (options can be minted without collateral as long as they are destroyed before the trade ends)
Competitive pricing, as bids/pricing are determined by market supply and demand
Allows users to sell options before expiration
Options can automatically execute cash-settled options
Anyone can create new options if the product is whitelisted
Allows operators to act/trade on behalf of users
The main features of the Gamma protocol that enhance capital efficiency in DeFi options trading include: margin improvements, European cash-settled options, and flash-minting.
Margin Improvements
The Gamma protocol lays the foundation for more capital-efficient options starting with spreads. Opyn-specific spreads allow long otokens to collateralize short otokens, enabling users to use the maximum loss of the structure as collateral.
European Cash-Settled Options
European cash-settled options allow for the secure construction of spreads, thereby increasing profit margins.
European options mean that the option holder can only exercise the option at expiration. Cash settlement means that the option holder does not have to provide the underlying asset to execute. Instead, the option settles in the collateralized asset, and the option holder receives a cash payment upon exercise (the value difference between the exercise asset and the underlying asset price) and transfer.
Now that you understand how Opyn V2 works, we will learn how to leverage these improvements to our advantage and adopt more advanced options strategies.
Intermediate Options Strategies
The features outlined above make Opyn v2 more capital-efficient for options trading in DeFi. This is the first step in competing with traditional markets, significantly reducing the collateral requirements for investors.
Spreads allow long otokens to collateralize short otokens, enabling users to use the maximum loss of the structure as collateral. Generally, spreads are a common method to reduce risk and margin requirements. Here are four of the most common options spreads:
Strategy 1: Bull Call Spread
A bull call spread, also known as a redemption spread, is an options strategy that involves simultaneously buying a call option at a specific strike price and selling the same number of call options at a higher strike price, requiring a net cash outflow. Both options have the same expiration date and underlying asset.
The result is a net debit to the trading account. The bull call spread reduces the cost of buying the call option, but it limits the profit from the asset price, allowing the trade to profit within a limited range.
Trading Scenario: If an investor believes the asset's value will moderately rise, they typically use a bull call spread. This situation usually occurs during periods of high volatility.
Maximum Profit / Maximum Loss: The potential profit of the bull call spread is limited to the difference between the strike price minus the net cost of the spread. If the stock price is equal to or above the strike price of the short call option at expiration, maximum profit is realized.
Maximum loss equals the cost of the spread. If the position is held to expiration and both calls expire worthless, the loss will be that amount.
- Position Details: The bull call spread involves two call options, resulting in a net debit to the trading account.
Buy a call option at a strike price above the current market price on a specific expiration date (long call option).
Simultaneously, sell a call option (the call option at a higher strike price has the same expiration date as the first call option).
Source: Investopedia
Strategy 2: Bull Call Credit Spread
A bull call credit spread, also known as a bear spread, is an options strategy that involves buying a call option at a specific strike price while simultaneously selling the same number of call options at a lower strike price with the same expiration date. By adopting this strategy, investors should expect the price of the underlying asset to decline.
One of the main advantages of this strategy is that it reduces the net risk of the trade by buying a call option with a higher strike price and selling a call option with a lower strike price. Typically, the risk taken on by this strategy is less than that of shorting stocks, as the maximum loss is capped.
Trading Scenario: When investors expect the price of the underlying asset to decline, they typically use a short position spread.
Maximum Profit / Maximum Loss: Maximum profit is equal to the credit received when initiating the trade. Maximum loss equals the difference between the strike price and the net credit received. Bull call credit spread options are considered a limited risk and limited reward strategy. The limits on profit and loss are determined by the specific strike prices of the call options.
Position Details: The bull call credit spread involves two call options, resulting in a net credit to the trading account.
Buy a call option with a higher strike price on a specific expiration date (long call option) and pay a premium.
Simultaneously, sell the same number of call options (short call option) with the same expiration date but at a lower strike price.
Source: Investopedia
Strategy 3: Bear Put Spread
A bear put spread, also known as a short put spread, is an options strategy that involves buying a put option while simultaneously selling the same number of put options at a lower strike price with the same expiration date for the same underlying asset. While this may seem similar to purchasing standard put options, this strategy exchanges potential profits for a lower cost than normal put options. As a result, the risk of this strategy is limited to the net premium paid for the position, and the risk of significant losses is also low.
The result of this trade is a net debit to the trading account. The total of all sold options (lower strike price) is less than the total of all bought options (higher strike price), so the investor must put in funds to initiate the trade.
Trading Scenario: When investors expect the asset price to moderately decline, they typically use a short put spread. This strategy profits when the price of the underlying security decreases.
Maximum Profit / Maximum Loss: The maximum profit obtained from using the put credit spread equals the difference between the two strike prices, minus the net cost of the options. Maximum loss equals the cost of the spread.
Position Details: The bear put spread involves two put options, resulting in a net debit to the trading account.
Buy a put option with a higher strike price on a specific expiration date (long put option) and pay a premium.
Simultaneously, sell the same number of put options (short put option) with the same expiration date but at a lower strike price.
Source: The Options Guide
Strategy 4: Bull Put Spread
A bull put spread (also known as a bull market put spread) is an options strategy that involves selling a put option at a higher strike price while simultaneously buying the same number of put options at a lower strike price with the same expiration date. Investors gain a net credit from the difference between the two premiums of the options.
Trading Scenario: When investors expect the price of the underlying asset to moderately rise, they typically use a bull put spread.
Maximum Profit / Maximum Loss: Maximum profit (i.e., net credit) occurs only when the asset's price is above the higher strike price at expiration. Maximum loss equals the difference between the strike price and the net credit received. The limits on profit and loss are determined by the specific strike prices of the put options.
Position Details: The bull put spread involves two put options, resulting in a net credit to the trading account.
Buy a put option at a lower strike price on a specific expiration date (long put option) and pay a premium.
Simultaneously, sell the same number of put options (short put option) at a higher strike price to earn a premium.
Source: The Option Bro
"Opening the Door" to New Possibilities
Options are an important tool in traditional finance that allows investors to express their positions more vividly. As options protocols become more capital-efficient and offer more contracts, this opens the door for crypto investors to explore more strategies, ultimately allowing the DeFi market to mature and become more efficient.
But let's be clear: this is not a comprehensive guide applicable to all options strategies. In fact, this is just the tip of the iceberg. Traditionally, investors can execute an infinite number of strategies using options. This includes call options and put options, paired puts, straddles, iron condors, butterflies… you get the idea.
You can use a lot of options.
We are just exploring all possible things, so make sure to stay tuned to the world of DeFi options.
