Traditional Hedging
Hedging options explained
In this section we will do a round up on hedging and the types of hedges that exists and how we adopted it to our protocol. It's important to note that the terms "equity swap, call option and put option" in our context might not carry the same specific contractual implications as in traditional finance.
Equity Swaps
Call Options
Put Options
Equity Swaps
In traditional finance, an equity swap is a financial derivative contract where two parties agree to exchange cash flows, often with one stream tied to the returns of an equity index or stock, and the other stream typically based on a fixed or floating interest rate. Equity swaps are used for various purposes, including gaining exposure to a particular equity market without directly owning the assets or for hedging purposes.
Example:
Party A might agree to pay a fixed interest rate to Party B.
Party B agrees to pay the return on a specified equity index to Party A.
The payments are based on the notional principal amount, and the parties exchange cash flows periodically.
in summary, Equity Swaps can be structured in different ways to meet the specific needs of the parties involved.
Call Options & Put Options
In options trading, call and put options are types of financial derivatives that give the holder the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a predetermined price (strike price) within a specific time period (expiration date).
The main difference between call and put options lies in the direction of the underlying asset's price movement that benefits the option holder:
Call Options: A call option provides the holder with the right to buy the underlying asset at the strike price before the expiration date. Call options are typically used when the investor believes that the price of the underlying asset will rise. If the price of the underlying asset increases above the strike price, the call option holder can exercise the option, buying the asset at the lower strike price and potentially sell it at a higher market price, thus making a profit.
Put Options: A put option, on the other hand, grants the holder the right to sell the underlying asset at the strike price before the expiration date. Put options are generally used when the investor expects the price of the underlying asset to decline. If the price of the underlying asset drops below the strike price, the put option holder can exercise the option, selling the asset at the higher strike price and potentially avoiding losses or even profiting from the decline in value.
So, in summary, the distinction between call and put options is based on the direction of price movement that benefits the option holder. A call option benefits from a rise in the underlying asset's price, while a put option benefits from a decline in the underlying asset's price.
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