Buying the Option
Current XCH price assumption is $10 / XCH
OPTION
- Underlying: 100 XCH
- Strike: 500 wUSDC.b (stable coin)
- Expiration: 2 weeks
- Option price: $510
Why would buyers like this option? I'll try to explain.
You gain exposure to the price movement of 100 XCH for about half the price. To really understand what that means you need to know a few things.
The options contracts value is made up of two components: Intrinsic Value, Extrinsic Value
You gain exposure to the price movement of 100 XCH for about half the price. To really understand what that means you need to know a few things.
The options contracts value is made up of two components: Intrinsic Value, Extrinsic Value
Intrinsic Value:
This is the value you get from executing the option right now.
Extrinsic Value:
The value that's derived by time left in the option.
The option contract above has an Intrinsic Value of $500. This value is the easier of the two to calculate.
1000 (XCH value) - 500 (strike price) = $500
The option is being sold at a $10 premium or $0.10 per XCH over the current XCH value. So you could say the Extrinsic Value is $10.
Extrinsic Value:
Think of it as the price you're willing to pay for the remaining time on this option. My bet as the buyer of this option is that sometime in the next 14 days the price of XCH will go up by over $0.10.
Who would buy this option?
Someone who is bullish on the underlying asset. In this case the underlying asset is XCH. I will only want this if I think XCH is going up. Part 3 of Know your options will talk about what to do if you think the price XCH is going down.
Assuming the price of XCH is $10/XCH and there are 2 weeks left until the option expires then I get the following benefits.
If the price of XCH goes to 10.50/XCH in the first week then the options Intrinsic value goes up by $50.
If the price of XCH goes to 10.50/XCH in the first week then the options Intrinsic value goes up by $50.
1050 (xch value) - 500 (strike price) = $550 (intrinsic value)
At this point you have 3 options.
- Exercise the option.
- Attempt to Sell the Option
- Do nothing.
Exercising the option
If you have the 500 wUSDC.b tokens, then you can execute this option. You'd pay 500 wUSDC.b and would receive 100 XCH. You could then sell the XCH to convert it to wUSDC.b or keep the XCH. It all depends on what your goals are. If you're looking to make wUSDC.b then sell the XCH.
Sell the option
This option contract's Intrinsic Value is now $550. You could sell this contract for $550 at minimum. If there was still a lot of time remaining on this option, you could add a few dollars for Extrinsic Value too.
Do nothing
The price could move more. You don't have to make a decision until the option is closer to its expiration date. But here is some real danger here.
DANGER:
Unlike normal stock options that will be exercised for you if they're in the money at the time of expiration. With Chia Options, this is the sole responsibility of the option holder. If you wait until 30 minutes before expiration to try to sell your option, you may not be able to. Because of how blockchains work, these get very risky around the time of expiration. I'll try to explain that in more detail in another post.
If you forget to execute your option by the expiration date and time, then the $510 premium was wasted.
DON'T FORGET TO EXERCISE YOUR IN THE MONEY OPTIONS - FAILING TO DO SO WILL MAKE YOU LOSE 100% OF THE PRICE YOU PAID FOR THE OPTION
Questions:
But why not just buy the 100 XCH at $1000 if you are just going to turn around and buy it at $1010 ($510 for option + $500 Strike) at a later date, doesn't that just lose money?
Yes, you are out $10 on this trade over buying straight XCH. But you are only exposed for $500 if the price goes the other way. If the price were to hit $6 / XCH the option still has $100 of Intrinsic Value and you could sell it still for $100 + Extrinsic Value. You still lose ~400 just like if you held 100XCH. But if the price fell to $3/XCH, your max loss is still the original $500, not the $700 if you held the XCH.
But when the price goes up, you capture all of the upward movement. If the price jumped from $10/XCH to $13/XCH then your option looks like this:
1300 (xch value) - 500 (strike price) = $800 (intrinsic value)
Your $510 investment returned $290 or ~56% assuming you sell the option and don't execute it.
If you bought 100 XCH @ $10, then you'd make $300 on your $1000 investment or 30%
In reality when you go to sell this contract in the secondhand market, you may need to discount it below the intrinsic value, so it is more likely to be picked up by arbitrage bots quickly. But knocking $10-15 off the contract price will still give you a good return. You certainly want to try to ensure you sell the contract or execute it before the expiration period. If you don't, your return will be -100%.
If I was a betting man (and I am), I can see options makers purposefully making options expire during times that most of the world is asleep in hopes people forget to exercise their option in time.
Moral of the story
Options are very powerful tools. Be sure you understand what you're purchasing. If you don't understand the risks involved, try to learn more about it before getting involved. The biggest thing to remember is accepting the offers gives you the responsibility for its execution. No one will execute it for you and if you forget to do it then you have lost money.
The Mayor
X: @MayorAbandoned
X: @MayorAbandoned