Managing risk is an essential part of securing your gains from unwanted volatility.

In addition to simpler things you hear all the time such as portfolio diversification, risk can be further minimized by hedging – the process of getting into a position opposite the existing one to offset potential investment losses. Hedging can also be considered a sort of insurance that minimizes the effects of negative price action on your holdings.

Now, there are multiple ways to hedge against risk. In this article, we’ll be going over different financial derivatives and how they can be leveraged as a hedge – more specifically options and futures contracts.

We’ll also cover a lesser known (at least in crypto) options strategy that goes hand in hand with hedging – debit spreads. This is a strategy that’ll be relatively easy to execute with Knox, giving you a straightforward way to protect your assets against the volatility of the crypto markets while earning yield!

Let’s get straight into it!

Before diving into what debit spreads are and how you can utilize them, let’s go over the simpler strategies – buying derivatives.

Like I said, there are 2 types of derivatives we’ll cover; futures and options contracts. If you’re unfamiliar with either one, here’s a short explainer for both. If you’re already well-versed, as I’m sure most of you are, skip to “Hedging Spot With Futures”

Futures are financial contracts obligating 2 parties to exchange an asset at a predetermined future date and set price.

So, futures can either be used to speculate on the price of an asset or to hedge an existing position. If you want to make money off of prices going up, you’ll go “long” and if you believe prices will go down, you’ll go “short”. Futures are also generally used in tandem with high leverage, allowing traders to gain exposure or maximize their profits for a minimal amount of capital.

Options are financial contracts giving a buyer the right, but not the obligation, to buy or sell an asset at a specific price by a specific time. 

As options don’t obligate you to do anything, and only cost a small premium, they’re generally beneficial as hedging tools. Thanks to their mechanics, they also put a bunch of different strategies on the table – most of them being for capital protection.

Let’s get to the fun stuff; how you can use this information to your advantage.

Generally, if you’re afraid of high volatility on a specific asset, you might want to reduce your exposure or entirely close your position. However, some users want to maintain their holdings while hedging to create exposure as neutral as possible.

Hedging an existing position with futures contracts is as straightforward as opening a position opposite of the one you want to hedge for. Here’s an example:

You already hold some $BTC. While you want to maintain exposure to the potential upside, you also want to make sure you have some cushioning in the event that prices dip lower. So, you’ll also open a short position. If prices happen to go down, you’ll have offset the losses on your spot position with profits from your short position.

This is similar to using futures, but generally more straightforward if you have a solid understanding of how options work.

Since buying an option contract gives you the right to buy or sell an asset at a specific price, they also provide added flexibility – and the maximum downside you have is the cost of the premium.

An easy strategy to hedge either an existing spot position or a position underwriting covered calls – such as our vault – would be to simply buy put options at a slightly lower strike price. This is also called a protective collar, more of which you can read in this article.

Now that we’ve covered the basics of hedging with different derivatives, let’s dive into debit spreads: a type of options strategy that creates a range (or spread) in which a trader can make a profit.

A debit spread is an options strategy where you simultaneously buy and sell an option of the same type with different strike prices resulting in a net outflow of capital or “debit” for the trader, due to the purchased option costing more than the sold option.

This is contrary to credit spreads, where the trader buys and sells two options of the same type, and makes a profit off of selling a higher premium than the one he buys, resulting in a “credit” to the trader’s account.

So, credit spreads result in net gain from premiums, and debit spreads result in net loss from premiums. Why would you use debit spreads instead of credit spreads if you initially make a loss doing so?

Even if the strategies sound similar, these two spreads are inherently different and used in different situations. However, we can boil it down to a few key differences:

• The maximum profit for a credit spread is the net premium. Credit spreads can be used to mitigate risk if the market moves in the opposing direction.

• Debit spreads allow you to limit the total amount of losses, while also allowing for greater upside – especially when the market sees moderate price action.

Something to keep in mind – the potential loss for a credit spread can be higher than the initial premium collected, whereas with debit spreads downside is limited and known.

Let’s get into the two different types of debit spreads, and how you can implement them:

As I’ve explained, a debit spread is a strategy consisting of using two options of the same type to create a range consisting of both a lower and an upper strike price.

Implementing a bull call spread limits losses on an underlying asset, but also caps potential upside. So, if you think an asset will have a moderate price increase – not too much – you can opt to use this strategy. It’s similar to writing covered calls in that you have a certain amount of opportunity risk – the possibility of missing out on appreciation above the strike price.

So, a bull call spread is implemented in anticipation of slight price appreciation. Here’s how it would work in action:

Let’s say Bitcoin currently trades at $19,000. You buy 1 $BTC call option expiring December 1 at a strike price of $20,000. Simultaneously, you write 1 $BTC call option expiring December 1 at a strike price of $21,000.

If $BTC trades under $20,000 at expiry, the trader only loses the net premium paid. If $BTC trades at, say $21,500, the trader profits the spread of $2,000 but misses out on appreciation above $21,000.

So as a result, you gain the upside exposure of a call option with a very minimal amount of capital by offsetting the premium paid with a premium sold.

As is obvious from the name, bear put spreads are essentially the opposite of bull call spreads; you’d want to use this strategy when anticipating a moderate-to-large decline in the price of an asset.

You buy a put option while simultaneously selling the same type of put option with the same expiration date at a lower strike price. As I explained with bull call spreads, the maximum profit you can make with this strategy is the difference (spread) between the strike prices, the maximum loss being the net cost of the options.

Contrary to a bull call spread, you’ll gain the downside exposure of a put option with a minimal amount of capital.

While gaining exposure for cheap is already very practical, the great thing about debit spreads is their predictability.

Maximum downside merely consists of net premiums paid, and the maximum upside is however wide your spread is – allowing for an extra bit of flexibility depending on your risk tolerance.

Debit spreads are also a handy way to hedge your positions in our upcoming vaults – either in covered calls, or cash-secured puts writing. We’ve already emphasized the predictability of our yields, but it never hurts to be extra careful!

Knox Finance provides structured products focused on predictable yields and risk management. Our initial strategies will be DeFi Options Vaults (DOVs) with built-in risk tooling — providing flexibility, capital efficiency, and predictable yields, while acting as building blocks for the wider ecosystem.

In collaboration with Premia, we achieve best-in-class options pricing and trade execution!

Discord | Twitter | Documentation | Website

Managing risk is an essential part of securing your gains from unwanted volatility.

In addition to simpler things you hear all the time such as portfolio diversification, risk can be further minimized by hedging – the process of getting into a position opposite the existing one to offset potential investment losses. Hedging can also be considered a sort of insurance that minimizes the effects of negative price action on your holdings.

Now, there are multiple ways to hedge against risk. In this article, we’ll be going over different financial derivatives and how they can be leveraged as a hedge – more specifically options and futures contracts.

We’ll also cover a lesser known (at least in crypto) options strategy that goes hand in hand with hedging – debit spreads. This is a strategy that’ll be relatively easy to execute with Knox, giving you a straightforward way to protect your assets against the volatility of the crypto markets while earning yield!

Let’s get straight into it!

Before diving into what debit spreads are and how you can utilize them, let’s go over the simpler strategies – buying derivatives.

Like I said, there are 2 types of derivatives we’ll cover; futures and options contracts. If you’re unfamiliar with either one, here’s a short explainer for both. If you’re already well-versed, as I’m sure most of you are, skip to “Hedging Spot With Futures”

Futures are financial contracts obligating 2 parties to exchange an asset at a predetermined future date and set price.

So, futures can either be used to speculate on the price of an asset or to hedge an existing position. If you want to make money off of prices going up, you’ll go “long” and if you believe prices will go down, you’ll go “short”. Futures are also generally used in tandem with high leverage, allowing traders to gain exposure or maximize their profits for a minimal amount of capital.

Options are financial contracts giving a buyer the right, but not the obligation, to buy or sell an asset at a specific price by a specific time. 

As options don’t obligate you to do anything, and only cost a small premium, they’re generally beneficial as hedging tools. Thanks to their mechanics, they also put a bunch of different strategies on the table – most of them being for capital protection.

Let’s get to the fun stuff; how you can use this information to your advantage.

Generally, if you’re afraid of high volatility on a specific asset, you might want to reduce your exposure or entirely close your position. However, some users want to maintain their holdings while hedging to create exposure as neutral as possible.

Hedging an existing position with futures contracts is as straightforward as opening a position opposite of the one you want to hedge for. Here’s an example:

You already hold some $BTC. While you want to maintain exposure to the potential upside, you also want to make sure you have some cushioning in the event that prices dip lower. So, you’ll also open a short position. If prices happen to go down, you’ll have offset the losses on your spot position with profits from your short position.

This is similar to using futures, but generally more straightforward if you have a solid understanding of how options work.

Since buying an option contract gives you the right to buy or sell an asset at a specific price, they also provide added flexibility – and the maximum downside you have is the cost of the premium.

An easy strategy to hedge either an existing spot position or a position underwriting covered calls – such as our vault – would be to simply buy put options at a slightly lower strike price. This is also called a protective collar, more of which you can read in this article.

Now that we’ve covered the basics of hedging with different derivatives, let’s dive into debit spreads: a type of options strategy that creates a range (or spread) in which a trader can make a profit.

A debit spread is an options strategy where you simultaneously buy and sell an option of the same type with different strike prices resulting in a net outflow of capital or “debit” for the trader, due to the purchased option costing more than the sold option.

This is contrary to credit spreads, where the trader buys and sells two options of the same type, and makes a profit off of selling a higher premium than the one he buys, resulting in a “credit” to the trader’s account.

So, credit spreads result in net gain from premiums, and debit spreads result in net loss from premiums. Why would you use debit spreads instead of credit spreads if you initially make a loss doing so?

Even if the strategies sound similar, these two spreads are inherently different and used in different situations. However, we can boil it down to a few key differences:

• The maximum profit for a credit spread is the net premium. Credit spreads can be used to mitigate risk if the market moves in the opposing direction.

• Debit spreads allow you to limit the total amount of losses, while also allowing for greater upside – especially when the market sees moderate price action.

Something to keep in mind – the potential loss for a credit spread can be higher than the initial premium collected, whereas with debit spreads downside is limited and known.

Let’s get into the two different types of debit spreads, and how you can implement them:

As I’ve explained, a debit spread is a strategy consisting of using two options of the same type to create a range consisting of both a lower and an upper strike price.

Implementing a bull call spread limits losses on an underlying asset, but also caps potential upside. So, if you think an asset will have a moderate price increase – not too much – you can opt to use this strategy. It’s similar to writing covered calls in that you have a certain amount of opportunity risk – the possibility of missing out on appreciation above the strike price.

So, a bull call spread is implemented in anticipation of slight price appreciation. Here’s how it would work in action:

Let’s say Bitcoin currently trades at $19,000. You buy 1 $BTC call option expiring December 1 at a strike price of $20,000. Simultaneously, you write 1 $BTC call option expiring December 1 at a strike price of $21,000.

If $BTC trades under $20,000 at expiry, the trader only loses the net premium paid. If $BTC trades at, say $21,500, the trader profits the spread of $2,000 but misses out on appreciation above $21,000.

So as a result, you gain the upside exposure of a call option with a very minimal amount of capital by offsetting the premium paid with a premium sold.

As is obvious from the name, bear put spreads are essentially the opposite of bull call spreads; you’d want to use this strategy when anticipating a moderate-to-large decline in the price of an asset.

You buy a put option while simultaneously selling the same type of put option with the same expiration date at a lower strike price. As I explained with bull call spreads, the maximum profit you can make with this strategy is the difference (spread) between the strike prices, the maximum loss being the net cost of the options.

Contrary to a bull call spread, you’ll gain the downside exposure of a put option with a minimal amount of capital.

While gaining exposure for cheap is already very practical, the great thing about debit spreads is their predictability.

Maximum downside merely consists of net premiums paid, and the maximum upside is however wide your spread is – allowing for an extra bit of flexibility depending on your risk tolerance.

Debit spreads are also a handy way to hedge your positions in our upcoming vaults – either in covered calls, or cash-secured puts writing. We’ve already emphasized the predictability of our yields, but it never hurts to be extra careful!

Knox Finance provides structured products focused on predictable yields and risk management. Our initial strategies will be DeFi Options Vaults (DOVs) with built-in risk tooling — providing flexibility, capital efficiency, and predictable yields, while acting as building blocks for the wider ecosystem.

In collaboration with Premia, we achieve best-in-class options pricing and trade execution!

Discord | Twitter | Documentation | Website