Thread by @staderlabs

The @terra_money's DeFi ecosystem is missing a key financial product:

'Options'

Here's why you should care:

- They have the potential to skyrocket your portfolio
- They protect your folio from price crashes

So, what are options and how do they work?

#ExplainLikeIm5 🧶 👇

Let's take a publicly-traded stock.

An options contract gives you the right to buy or sell this stock at a specific price.

But you are not obligated to do so.

That means:

You don't have to buy or sell the stock if it's not in your financial interest or advantage.

How?

Here's how it works in practice.

Let's take two people - Alex and Kate.

Alex believes that the share price of company X will increase to $40 per share.

Currently, it's trading at $30 per share.

So this is what Alex does:

He enters into an options contract with Kate...

Where he can buy 100 shares of this company at $30 per share, anytime in the next 6 months.

This called a CALL option contract.

Plus, he pays her $200 as a premium for entering into the contract.

Now let's see what happens:

Scenario 1: Stock price hits $45 per share in the 5th month.

Alex's prediction was right.

Now he gets to buy the 100 shares at $30 per share from Kate and sell it in the market for $45 per share.

Making a good profit of $15 per share.

Let's look at another scenario:

Scenario 2: Stock price declines to $25 per share right before the 6 month period ends.

Clearly, Alex was wrong.

So he decided not to buy those 100 shares from Kate.

His loss is limited to the $200 he paid for entering into the contract.

In fact:

Kate gets to keep the $200 no matter which way the price goes.

In short:

The buyer of the call option has the right to buy the underlying asset (stock in this case).

But he doesn't have to if it doesn't suit his financial interests.

Next: Put Option

Alex buys 100 shares of company X from the market for $30 per share.

And he wants to protect this investment from possible price drop.

So, he enters into an options contract with Kate.

Where he can sell these 100 shares to Kate at $25 per share anytime in the next 6 months.

This contract is called the PUT options contract.

Again, Alex pays Kate a premium of $200 for entering into this contract.

Let's take 2 scenarios:

Scenario 1: Stock price plummets to $20 per share in the 5th month

What does Alex do?

Thanks to the put options contract, Alex can sell the shares at $25 per share.

And limit his losses to $5 per share instead of $10.

Plus the $200 he gave to Kate.

In essence, his total loss was only $700 instead of $1200.

On to the next scenario:

Scenario 2: Stock price shoots to $45 per share right before the 6th month ends.

Alex doesn't have to sell his shares to Kate.

Instead:

He can choose to sell them in the open market and make a $15 profit on each share.

Or continue to hold them.

What about Kate?

She gets to keep the $200.

With a call option, you get to skyrocket your portfolio.

And with a put option, you get to protect it against price crashes.

Now let's get back to Terra.

How will options make DeFi more fun on Terra?

And how will it help you boost your gains?

Terra already has @mirror_protocol.

So you can buy mAssets which track publicly-traded stocks.

And farm them or short them.

The missing piece in the puzzle?

Options.

It adds another level of thrill and leveraging capability.

And protection against price dips.

Plus:

Since these options contracts will essentially be smart contracts...

You can trade far more transparently and with decentralization than traditional finance.

Several blockchains already have options for their DeFi community.

For example:

@ethereum has @HegicOptions.

And, @solana has @ZetaMarkets.

It's about time @terra_money got one too.

We hope you enjoyed the first explainer in our 'Explain Like I'm 5' series.

What should we simplify next?

#ExplainLikeIm5