Hedger is a system of smart contracts that makes it possible to write and settle option contracts on Ethereum.
What are option contracts?
An option contract is an agreement between Writer and Buyer that gives Buyer the right but not the obligation to either buy (Call Option) or sell (Put Option) Writer’s underlying assets (e.g. Ethereum) at a predetermined (e.g. 200 DAI) price (known as the Strike Price) anytime before a specified date (known as the Expiration Date) in exchange for an immediate premium fee to the Writer.
What are the benefits of BUYING options?
The volatility of the crypto market and increased trading activity implies significant demand for derivative instruments. Options are one of the key financial instruments that can help people hedge their assets and increase cost efficiency.
Example use-case: hedging CDPs. Let's say Alice has 10 ETH collateralized at MakerDAO with a 200 DAI liquidation price. To protect herself from a 13% liquidation fee in case ETH price plunges to 200, she purchases 10 Put option contracts with Expiration Date set for the anticipated duration of her loan and a 230 DAI Strike Price (200DAI liquidation price + 13% liquidation fee + 4 DAI Premium or cost of the option contract). Now if the price drops to 200 anytime during the duration of Alice’s loan, Alice will have to pay a 260 DAI liquidation penalty fee, but she will be able to recover her losses by exercising her purchased Put options (buying 10 ETH @200 DAI and immediately selling it to Option Writer @230 generating 300 - 40 Premium paid for contracts).
What are the benefits of UNDERWRITING options?
Option Writers are able to generate additional income by locking up underlying assets to guarantee option settlement.
For example, a user that owns ETH and is willing to sell @300DAI within the next month can earn a 3% premium by writing a call option with a strike price of 300 and locking their ETH until next month. If there's enough demand and the Writer is able to keep re-underwriting assets with a 3% monthly premium, over a 12 month period this can compound to over 40%.
Additionally, whether purchased option contracts get executed or expired, option Writers always receive immediate premiums from Buyers. Writers even get to select their desired strike prices and lock up periods - generating extra guaranteed income in exchange for possibly executing orders they were willing to execute on anyways.
How does it work?
Today option trading and especially writing, is available through centralized exchanges which are susceptible to counter-party risk and limited to experienced, high net worth individuals, institutions and hedge funds.
Hedger uses a suite of Ethereum smart contracts to allow anyone to write and settle option contracts with minimal counter-party risk. Writer’s collateral is held in escrow smart contracts and released to option Buyers if exercised or returned if expired. Option Writers and Buyers interact with Hedger smart contracts through Relayers.
Recent demand for CDPs resulted in over $500 million worth of Ethereum locked up as collateral for loans/margin trading. Hedger’s first Relayer - CDP Hedger will allow CDP owners to get coverage against liquidation penalties with put options.
Get early access to Hedger’s development tool to build your own relayer and start earning fees.