Call Options 101

Here are some resources to learn more about options in general before diving into Hook:

  1. OptionAlpha
  2. Investopedia
  3. Fidelity

:moneybag: How do traders make money buying a call option?

There are three important terms for a particular call option:

  1. The Strike Price: the price at which the asset may be purchased.
  2. The Expiration Date: the date at which (or, for some types of options, by which) the option owner must pay the strike price to purchase the asset
  3. The Underlying Asset: the specific underlying asset the option owner can buy for the strike price at the expiration.

An example (not specific to Hook):

Let's suppose asset A is worth 100ETH today. Trader Tom decides they believe the asset will increase in value next month, but Tom does not have 100ETH to buy asset A. Instead, Tom purchases an option with a strike price of 120ETH that expires in 30 days from Sally. Tom pays Sally 5ETH for this option, an amount known as the premium.

The value of the option at its expiration is simply the price of Asset A - 120 ETH (the strike price). Three things can happen:

1. Asset A is worth less than 120ETH

Tom's option is worthless, because if Tom exercised the option (paid 100ETH for Asset A), they'd be paying more than the asset is worth (and, presumably, would be able to purchase Asset A for less elsewhere).

Sally keeps the 5ETH they earned from selling the option.

2. Asset A is worth 120ETH or more, but less than 125ETH

In this case, Tom's option is worth something, but Tom still lost money on this trade because they had already paid more than the option was worth at the beginning. However, Tom did not lose all of their capital because the option is worth between 0-5 ETH.

3. Asset A is worth more than 125 ETH

In this case, Tom makes money on the trade. Tom's overall earnings are Price(Asset A) - 125ETH.

For example, if Asset A is worth 130ETH, Tom earned 5ETH, and 100% gain in 30 days (vs. a 30% gain of simply purchasing Asset A). If asset A is worth 200ETH, Tom earned 70ETH, a 1400% (vs. a 100% gain if Tom simply purchased Asset A).

:passport-control: How are call options used? How does that look for NFTs?

1. Capital-efficient long positions

Call options offer a way to get much of the upside if an asset increases in value while investing much less money. As a result, buying a call option is much riskier than purchasing the asset directly because in many cases you will loose all of your capital. See how by reading our example above.

2. Earn money selling call options

Traders often sell a call option when they believe it will increase in value, but not more than a certain amount in a period. If they're confident in this belief, they can be paid to sell the potential earnings if the asset increases more than that amount by creating and selling a call option to another trader on that asset. Even if the asset doesn't increase in value, the option seller will keep the proceeds from selling the option. Importantly, selling a call option IS NOT a short position: if the value of the underlying asset decreases, the option seller loses money, and if it increases they'll make money.

In the case of NFTs, the price of the assets change frequently and dramatically, which means that there is a lot of risks that the value of the assets will actually increase by some significant value in a given period. Sellers of call options must be paid quite a bit to take this risk, meaning that they can earn a lot of money as long as they are careful in managing their positions.