Professional proprietary trader of 8 years; CIO of Sparrow, leading options trading platform
Hedging is a trading strategy to reduce or eliminate the risk of holding one position by taking on another position.
One simple example is to compare it to insurance, which is basically a form of hedging.
Options and its trading terminologies may sound complex. However in layman terms, the mechanics behind options trading can be referenced to the insurance industry — where people pay a premium to insure their health. In fact, we could say that insurance providers are simply options sellers!
Here’s an example of how you can use options to insure your BTC.
Example: Insuring your BTC by buying a put option
If you hold 1 BTC you bought at $7,000 and is long term bullish but afraid of short term volatility, you can buy a put option priced at $200 to protect your position against a possible crash.
If BTC nosedived, your maximum loss will be capped at $200.
If BTC dipped to $6,000 on Settlement Date, you will lose $1,000 value from your BTC. However, your put option will have an intrinsic value of $1,000 and can be sold for that amount thus offsetting potential losses and limiting your loss to your Premium Payable.
Options can be used as an effective hedging tool — as a protection against market volatility for cryptocurrency holders or as part of a wider trading strategy for professional traders.
The author Adrian is the CIO at Sparrow Exchange, an options trading platform with trades settled transparently by smart contracts.
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