What are Options Contracts?
The general definition of an options contract according to Investopedia.com is:
“An options contract is an agreement between two parties to facilitate a potential transaction on an underlying security at a preset price, referred to as the strike price, prior to or on the expiration date.”
There are two types of options contracts, Call Options and Put Options. Call options give the holder the right but not the obligation to BUY an asset at a set price for a set time frame. Put option give the holder the right but not the obligation to SELL an asset.
Calls contracts are bullish positions and are often used as a leveraged trade when market prices are expected to rise. Put contracts are bearish trades usually bought to profit from declining market prices but are also used to protect current holdings from falling prices.
Benefits of options contracts
There are many benefits and reasons to trade options depending on a traders overall strategy. As mentioned above, a Call option (call) is many times used as a way to leverage a trade, so what do we mean by that? To fully understand some of the benefits we need to establish that each option contract is represented by a fixed amount of the underlying asset. The next important factor to understand is that the cost to buy or open a position, known as the premium, is less than the cost of the asset itself.
In our use case for Defi crypto options each contract represents one token or coin. This is where the leverage comes in. Lets take the ETH as an example. One (1), 1 Week Call Option on ETH at a strike price of $3,545.71 will cost the trader $159.43 while the current market price is $3,545.71. This means that for just under $160 the trader is able to leverage 1 ETH at the market price. If the price of ETH were to move up to $4,000 before the 1 week expiration the trader would have a gross profit of $454.29 — $159.43 for a net profit of $294.86 or a 184.9% ROI.
This is an excellent example of a trader who wants all the price action of a 1 ETH without having to actually own 1 ETH. Another benefit here is that as that we all know one week in crypto is a long time. What if during that week the price never moves above the strike price of $3,545.71, or even worse, what if the price of ETH were to fall back to the $3,200 level? In most cases when a trader is long a leveraged position and the price falls their account can be liquidated. Whereas with options the loss is limited to the premium paid to open the call. Calls can provide traders a lower cost of entry on leveraged positions without the risk of margin calls or account liquidations.
Put options are used to protect investors from falling prices on assets they own or as a form of speculation if a trader is expecting a bearish trend and wants to profit from price drops. For instance gold miners employ options to protect themselves from price fluctuations on gold. I’ll use the example of a Bitcoin miner in this example for trading a put option.
If the price of Bitcoin were to fall it may cut into profits for the business. Put options can be used as a hedge or insurance against down trending market prices. Some of the worlds largest gold miners use options to maintain corporate profitability regardless of the price of gold. The same is true for oil and natural gas companies. Puts are also used by multinational companies operating abroad. Options can be used to hedge foreign currency risk on revenue in these countries. The same can be useful for e-commerce sites that may want to accept cryptocurrency as a form of payment.
A good example of this would be the Steam Store, one of the largest online game retailers. For a short time, they began to accept Bitcoin and Litcoin as a payment option to buy video games. However this was short-lived after crypto markets became more volatile. A game sold for $50 in BTC one day might only be worth $40 a few days later. Corporations don’t like to see major prices changes that drastically effect the bottom line. Using Put options could have been one way the online retailer could continue to accept crypto payments.
From the standpoint of the average crypto investor, dips can be stressful. Giving traders an opportunity to cash in on these short term crashes will help turn paper hands into diamond hands and long term holders.
In the image below we have another at the money option, this time a WBTC Put Option with a strike price of $48,280 that expires in 1 week. The cost to open this option is $2,170.91 and the trade will be at break-even if the price of WBTC reaches $46,109.09. A price move back to $45,000 would give the trader a net profit of $1,109.09.
The evolution of options contracts
The first recorded options trade dates back over 2,300 years to 332 BC when Thales of Miletus bought the right to buy olives before the harvest was ready. He used a small investment to secure the right to use all of the olive presses in the area, making Thales the first person in recorded history to open a Call Option contract. Later in the year 1636 when tulip mania hit Europe options were widely bought to speculate on the price of tulips.
Options were first traded on an organized exchange near the end of the seventeenth century in London were a formal market for Call and Put options was established. However, in 1733 options trading was banned for more than 100 years until trading was allowed again in 1860. A few years later in 1872 options contracts were introduced to financial markets in the USA. Finally after another 100 years n of the Chicago Board of Exchange (CBOE) and the Options Clearing Corporation (OCC) were formed in 1973.
Now in 2021 Risq Protocol will release the OptionsDesk, a decentralized platform offering 24/7 options trading to the global market. Fourteen crypto markets will be available at launch including WBTC, ETH, BNB, BCH, and more.
Options trading on any market carry a significant amount of financial risk, you should never trade or invest more than you can comfortably afford to lose. Join our Telegram or Discord to learn more about Risq Protocol, the OptionsDesk and other Defi dapps. Follow us on Twitter and Reddit to stay up to date with all the latest news and announcements.
