HEGIC PROTOCOL: An Overview

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Zainab Hasan
Rabia Ahmed
Arham Tariq

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Hegic Protocol

Contents

Hegic protocol is the non-custodial, decentralized, and on-chain Option trading platform built on the Ethereum blockchain. Hegic allows you to buy WBTC and ETH Options or sell ETH Options using the Hegic token. To sell, you have to provide liquidity.

What is an Option?

An Option is a smart contract that gives you the right to buy or sell an underlying asset at a specific price within a certain time frame. There are two types of Options which are the Call and Put Option.

Call Option 

A Call Option is a contract that gives you the right but not the obligation to buy an asset at a certain price on or before a particular date. A buyer is known as a holder. 

Put Option

A Put Option is a contract that gives you the right but not the obligation to sell an asset at a specific price within a particular time frame. A seller is called a writer.

Strike Price

A Strike Price is the fixed price at which you can buy or sell an underlying asset if the Option is exercised (i.e., if you decide to buy or sell an asset). For example, the Strike Price is the buying price for Call Options and the selling price for a Put Option.

Option Premium

The price of an Option contract is called an Option Premium. There are four ways to trade Options, which are:

  • Buy Call
  • Buy Put
  • Sell Call
  • Sell Put

Buy Call

A Buy Call is a price above the Strike Price that you can exercise your right to buy. You may be wondering why you should buy an asset above the current price. The reason is explained with the example below. A Premium is paid to make a Buy Call. The risk involved with a Buy Call is minimal, as the maximum amount you can lose is the premium paid.

For example, if the Strike Price of Ethereum is $500, you can place a call to buy it at $600 within a week. Instead of paying $500 for the Ethereum now, you will pay $100 (Premium), and once the price gets to $700, you can exercise your right to buy and have made a net profit of $100. Your net profit is $100 because the Premium is subtracted from the total profit.

If the price is at $600 or below at expiration, the Option will expire worthless, and you will lose $100 (Premium) rather than $500 if you had bought without using an Option.

Source: https://www.hegic.co/

Buy Put

A Buy Put is the price below the Strike Price that you can exercise your right to buy. A Premium is also paid to make a Buy Put. The risk involved with a Buy Put is minimal, as the maximum amount you can lose is the Premium paid.

For example, if the Strike Price of Ethereum is $500, and you place a Put-Call at $400 within a week at a premium fee of $10, you can exercise your right to buy once the price gets to $400 or below before the expiry date. You will make a profit of $90 because the Premium will be subtracted from the gain. If the price does not decrease below $500 at the end of the week, you will lose just $10.

Sell Call

A Sell Call is a choice you make to sell a Call Option when the price falls below the Strike Price. A Premium is paid by the buyer of the call to you. Risk is high, as you are obliged to sell at the Strike Price if the buyer exercises the right to buy.

For example, if the Strike Price of Ethereum is $300, and the price falls below the Strike Price at the contract’s expiration. The seller will get a profit from the Premium paid. If the price becomes higher than the Strike Price, the seller will have an obligation to sell Ethereum at $300.

Sell Put

A Sell Put is the choice you make to sell a Put Option when the price falls below the Strike Price. A Premium is paid by the buyer of the call to you. Risk is high, as you are obliged to sell at the Strike Price if the buyer exercises the right to sell.

For example, if the Strike Price of Ethereum is $300, the price rises above the Strike Price at the contract’s expiration. The seller will get a profit from the Premium paid. If the price becomes lower than the Strike Price, the seller will have an obligation to buy Ethereum at $300.

Factors Affecting Option Prices

Three elements affect the Options price. These elements are:

Time to Expiration:

The time remaining for an Option contract to expire is called the Time to Expiration. A holder or writer can decide to exercise the, stop the contract to take profit or loss before the contracts expire, or let the contract expire and become worthless. 

Underlying Asset’s Price:

This is the Strike Price set for an asset. Any price above the underlying asset’s price in the Call Option is called out of the money. At the same time, any price below it is called in the money. The reverse is the case for the Put options. An increase in the underlying asset price causes an increase in the Call Option Premium and a decrease in the Put Option. A reduction in the asset price causes a decrease in the Call Option Premium and an increase in the Put Option. 

Volatility:

This is the extent to which an asset’s price swings. It can be a high volatility asset or a low volatility asset. The higher the volatility, the higher the price, and the lower the volatility, the lower the price. 

Conclusion

In conclusion, Hegic uses the American style Options to exercise your right before the expiration date. This style of usage is an excellent advantage of Hegic over the other decentralized Option trading platform.

Also read about Opium protocol.

Co-authors

Zainab Hasan
Rabia Ahmed
Arham Tariq

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