Yield farming has been one of the popular concepts in the DeFi (Decentralised Finance), allowing users to generate more income on their existing crypto assets using different strategies. This may include lending, arbitraging, providing liquidity, and margin trading, among others, as a method to generate more crypto.
This has proven to be a much better way for investing in cryptocurrencies than the previous method of HODLing crypto assets. We had previously talked about the basics of yield farming, and some of the commonly employed strategies in our blog, and now, we are coming to you with yet another way to systematically increase your crypto assets – through options.
The Basics
With derivatives, especially options on offer for all the popular cryptocurrencies, systematically selling options becomes an extremely lucrative way to make passive income. If you aren’t aware of how crypto derivatives work or what crypto options are, here’s a small summary.
Derivatives are financial instruments that facilitate transactions based on an underlying asset, in this particular case, cryptocurrencies like Bitcoin. Some of the common derivatives are Options, futures, forwards, swaps, and warrants – each slightly different than the other.
An options contract is a type of derivative that allows the parties to buy or sell an underlying financial asset at a later date, at an agreed-upon price. These are broadly categorized into two different types – called put options and call options. Call options are the type of options contract that gives the buyer a right to buy the underlying asset at the agreed-upon price, before the date of expiry.
A put option, on the other hand, is the type of options contract that gives the holder a right to sell the underlying asset at the agreed-upon price. Usually, the purchaser of a call option believes that the price of the underlying asset will rise beyond the strike price (the mentioned price in the options), while the purchaser of put options usually bet on a decline in price.
How Yield Farming With Options work
The fundamentals of income generation through crypto options are basically the same as covered-calls. A covered-call is a transaction in which the investor sells call options equivalent to the amount of the asset he already owns. This option is extremely suitable if you intend to hold your crypto asset for a long period of time, but you don’t think there will not be a significant rise in the value in the near future.
These calls tend to be neutral in nature, i.e., neither bullish nor bearish in the short term. For instance, if you see the value of your crypto asset not increasing significantly in the short-run, you can choose to sell calls and generate income in the form of premiums.
For instance, assume you hold INR 1000 worth of XRP and don’t see the price of XRP making any significant changes, you can choose to sell call options with a strike price of, say, 1100 in 3 months valued at INR20.
If the price of XRP doesn’t increase past 1099, your call option would be worthless to the buyer (as he can buy the same quantity of XRP in the free market for a lower price), but you would have gained profits of INR 20. In this example, you would fetch an annual yield of 8%, something which would not have been generated if you were passively HODLing.
The Risks
However, it is essential to note that this yield farming method does come with its fair share of risks. For instance, in the same example, if the value of the XRP increases beyond 1100, to say 1500 – you will not be able to participate in the further increase beyond 1100. You’d have missed out on profits worth 400 for the premium you earned in selling the calls, which in this case is INR 20.
While you won’t necessarily lose money, you’d definitely have lost out on the long position you were holding and the potential long term benefits. However, there is another crypto option that could still enable you to hold on to your crypto, but you will have to buy back your calls – which would be worth much more than the original INR20 since the call is almost guaranteed to be made. If you got the call wrong (pardon the pun), you would have to choose between two losing alternatives, a decision that you will have to make based on the circumstances’ specifics.
It is easy to start trading in derivatives and earn passive income on your existing crypto using Delta. Our exchange has strived to be the most educational and trustworthy crypto derivative exchange for our users globally, and you can find more such educational posts on our blog.
