Newer DeFi platforms such as Friktion (on Solana) and Ribbon Finance (on Ethereum/AVAX) allow investments in crypto call options.

A call option is a financial derivative that give the buyer the right to purchase an asset at an agreed upon strike price on or before a set exercise date.

A covered call option is a special form of a call option where the seller of the option also holds an equivalent amount of the asset. This reduces the downside risk at the expense of lowering the upside profits.

This is best understood through an example:

Assume that we buy 1 $SOL at market price for $90 (USD). We wish to write a call option for a strike price of $125 (USD), expiring in one week from today. Since we purchased the asset prior to writing the call option, this is a covered call option. We sell this call option for a premium of $10. Our profit/loss at the time of expiry (one week from today) will depend on the price of $SOL at that time. One of two things can happen:

1. Price of $SOL is below the strike price ($SOL<$125): The buyer will not exercise the option since he can purchase $SOL cheaper on the market. The option will expire out of money. We keep our 1 $SOL plus the $10 premium. This is exactly as if we got paid $10 to hodl during this time.
2. Price of $SOL is above the strike price ($SOL>$125): The buyer will exercise the option and buy our 1 $SOL at $125. Since we bought our $SOL at $90, we are left with $125-90=$35. Adding the premium leaves us with a net profit of $45.

We plotted this price action in the figure below and included the HODL and simple CALL options as reference.

You can play with a code used to generate this plot here.

A few take-aways:

1. Notice how a covered call option give a trades-off between upside of large price increases and downside of large price decreases.
2. Remember that covered call options are always profitable when the price increases past the purchase price.
3. We don’t effectively lose our entire position when the covered call option is exercised (even though it may seem like we do). In the example above, assume that the price of $SOL at expiry is $145. We receive $125+$10=$135, regardless. Which means we can immediately buy-back 0.93 (=135/145) $SOL (we lose 7% of our initial investment). Platforms such as Friktion use a similar mechanism to preserve capital.

In summary, covered call options present a relatively safe and effective way of earning yield on digital assets.

Want to learn how you can invest in covered call options? Schedule a consultation with our team today.