What are Options?
Last updated
Last updated
An option is a contract which conveys to its buyer the right, but not the obligation, to buy or sell an underlying asset at a strike price on an expiration date, paying a premium for that right. Options are a financial primitive from which one can build many different more complex financial instruments. This is useful for protecting yourself (a.k.a hedging) against possible price changes in the asset, as well as speculating on these price changes.
When buying options, the potential loss is limited to the amount paid for the options (the premium). Unlike futures, the holder is not required to buy or sell the asset. Currently on Siren you can buy cryptocurrency options from the market and you can sell them back to the pool as well.
Buying a call is a strategy that's used if you think a cryptocurrency's price will rise and can be seen as a substitute for buying cryptocurrency while offering limited risk. It usually costs less to buy an option than it does to buy the underlying cryptocurrency, and is generally considered less risky than a position in cryptocurrency. You can hodl a cryptocurrency indefinitely, but you can only hold a call option through its expiration date. If the cryptocurrency price does not rise above your strike price by the expiration date, the call option will expire without being exercised.
You have to decide whether to buy a call with more or fewer days to expiration. First, an option with fewer days to expiration usually has a cheaper premium (cost) than an option with more days to expiration. This is because the more time there is until expiration, the greater probability there is that the price will change, and thus the greater probability that the option will go into the money and be profitable to exercise.
Buying puts is a strategy that profits from a drop in a cryptocurrency's price. Shorting a cryptocurrency directly (i.e. by selling it now and buying it for a lower price in the future), rather than through a put, can have high margin requirements, and some brokers restrict shorting entirely. The alternative to shorting is to buy puts, which has limited risk but unlimited profit potential.
You have to decide whether to buy a put with more or fewer days to expiration. First, an option with fewer days to expiration usually has a cheaper premium (cost) than an option with more days to expiration.
Options are designed to be a tool for transferring risk from one trader to another. Therefore, when you buy an option, you are limiting your risk by transferring it to the writer of this option. When you write an option, you are accepting the risk from whoever bought the option. An option writer must accept that their underlying asset may be sold at the option strike price, which may be less than the underlying value of the asset at the time of expiration.
NOTE: This is a living document that will continue to be updated as Siren evolves. To contribute, please visit Siren on GitHub. Specific questions may be answered and technical guidance may also be provided from time to time in the Siren Discord to those who are interested in building on top of the protocol.
