Hedging with Oddz — A Beginner’s Guide to Minimizing Crypto Risks
You must have heard the term ‘hedge’ thrown around a lot. Especially if you happen to have friends who trade. They have a way of terrorizing laymen with words. Hedging is not as complex as they will have you believe, though. It’s pretty simple. In this article, we take you through the basics of hedging and how it can step up your crypto investment strategy.
- Hedging is a key risk management strategy where you purchase an asset to offset the risk from another.
- It mitigates the negative impacts of market volatility.
- Hedging mostly involves the use of derivatives.
- Hedging leads to lower risk, as well as profit.
- Prominent institutional and individual investors, portfolio managers, exchanges, and corporations apply hedging strategies to diversify their portfolios.
What is Hedging
Hedging is like insurance. It’s similar to buying coverage from an insurance provider in the sense that it protects your asset from an event that can bear negative impacts. That is not to say hedging eliminates the event from happening. Even if it does happen, the effect on your assets is minimized. Instead of buying premiums from an insurance provider, hedging requires you to use financial instruments and offset the risks. That is, you need to make an investment to protect another with negative correlations.
You are a tomato farmer. You want to sell your tomatoes for Rs. 10 each in June. But you are worried that the import of tomatoes to the local market will reduce the price to Rs. 6 by the time you harvest. You can’t let that happen, since the price won’t be enough to even cover the expenses. So you sell ‘tomato futures’. According to the ‘tomato futures’ contract, you agree to sell your tomatoes at a price of Rs. 8 in June to the futures buyer. Regardless of where the market heads, it gives you a safe position. Lower than the price you were expecting, but still high enough to give you a decent profit. Hedging helps you offset the losses and earn a predictable income.
Not surprisingly, hedging has made its way to the crypto market too. They are integral to the sustainable growth of a market known for its volatility. Crypto hedging is mostly based on crypto derivatives, blockchain-run products that derive value from underlying assets like cryptocurrencies, fiat currencies, shares, commodities, etc. The two widely used crypto derivatives are futures and options.
We discussed futures in the above example. Here, two parties agree to purchase or sell an asset before the expiry date at a predetermined price. If that sounds too rigid for your liking, you should check out options. As the term gives it away, here the trader has the option to not activate the contract. That is, an options contract grants the right to buy or sell an asset, but not the obligation.
Options clearly offer more flexibility when compared to other crypto derivatives. So, let’s take a better look at them.
How Put Options Work as a Hedge?
There are two types of options — call options and put options. If call options work as great tools for speculation, put options give you a hedge against losses. And that’s what we’re here to learn about.
We’ll be honest. It’s a little puzzling at first sight, but well worth the head rush. So read on.
A put is an option contract that gives the holder the right, but not the obligation, to sell a specified amount of an underlying asset at a fixed price within a certain period. This fixed price is referred to as ‘strike price’. You pay the option seller a fee called ‘premium’ to get the put option. You anticipate your asset’s price to go down and buy the put option to offset the potential risk.
Let’s say you bought 10 XYZ tokens for $10 each. However, you feel that the project may not release its much-awaited product in the coming month as announced earlier. This could trigger a huge downturn. You plan on holding the asset, nevertheless. So, you buy 10 XYZ put options for a premium of $1 each. If the price goes down below $10 as you worried, the put options come to your rescue. Your 10 XYZ tokens are worth $10 each while the options contract is active. In the event the price goes above $10, put options give you the right to simply let the contract expire. All you lose is the $1 you paid as premium for each put option.
This is the reason why put options are an integral part of the world’s leading investment funds. We’re not just talking about the crypto industry here. For example, a gold mining company may purchase put options against the price of gold. Hedging prepares you to weather market volatility in the long run.
How to hedge with Oddz
As we discussed, hedging is extremely important in building a sustainable crypto portfolio. However, if you’re still getting acquainted with hedging and options, designing a hedging strategy can sound intimidating. We built Oddz to make it easier for you. Oddz is a trustless DeFi derivatives trading platform that expedites the execution of put options. You can buy put options from our platform as an insurance against the market volatility.
Here is how it works:
- If the market swings against your prediction, the options contract compensates you.
- If it goes in the intended direction, you can let the contract expire.
The idea is to safeguard the trader, regardless of the fluctuating market conditions. Currently, Oddz supports ETH, BTC, AAVE and AVAX. The following example will give you a better understanding of how you can use Oddz to your advantage.
Arun buys 1 ETH for $2000. He expects the value of Ethereum to go up in the coming days. Still, to be on the safe side, he buys an ATM (at the money) put option for ETH. (A put option is in ATM, if its strike price is equal to the spot price of the security. In this case, the strike price becomes $2000.) He had to pay $100 as the cost of the put option, including the premium and transaction fees. In two weeks, the price of ETH goes down to $1600, bringing the unrealized loss on the asset to $400.
However, since he has already bought a put option from Oddz, Arun is untouched by the downturn. He can claim $400, the difference between the strike price and the spot price of the asset, from Oddz while the contract is valid (7 days to 30 days).
Claim = Strike price — Spot price
= $2000 — $1600
If the price goes up, let’s say to $2250 in two weeks, he is still at a gain after deducting the premium and transaction fees.
Sounds good? It gets better. Oddz allows you to claim the insurance even after you’ve sold your asset. This is given that you make the claim before the contract expires. The insurance remains active, regardless of whether you hold or sell the asset after you purchase. You can also sell your insurance (put option contract) at Oddz Secondary Market for a discount. This is a great way to get back some or all of the premium you paid when you bought the insurance.
NOTE: The cost of the insurance depends on the Implied Volatility and other market conditions for the underlying cryptocurrency.
Making crypto trading risk-free
Trading is inherently risky. But with the right strategies, you can minimize the losses and earn significant returns from your investments. Perfecting the art of hedging goes a long way in building a robust portfolio. In this article, we took you through the basics of hedging and how you can apply it to the crypto market with Oddz Options. To get started with crypto hedging, Visit Oddz.
Learn more about Oddz options trading: An Introduction to Options Trading
Oddz is a trustless on-chain options trading platform that expedites the execution of call and put options contracts, conditional trades, and futures. It allows the creation, maintenance, execution, and settlement of trustless option contracts, conditional tokens agreements, and futures contracts in a fast, secure, and flexible manner.
It employs the synergies of Ethereum, Avalanche, Binance Smart Chain, Polkadot, and Polygon to unleash the potential of a decentralized options market. It focuses on building solutions that can propel the DeFi ecosystem by simplifying options trading and enhancing the user experience.