How to protect NFT collections with options and futures

Derivatives such as crypto options and futures offer speculators the opportunity to hedge against losses in the value of NFTs.

Using Ethereum as a reference market value, it is possible to use derivative financial products of ETH to offset the risks arising from the possible loss of value of NFTs. 

Indeed, the NFT market is often based on exchanges that take place in Ethereum (ETH), as many of them are in fact tokens based on this blockchain.

Since NFTs are usually sold in Ethereum, their value can be expressed in dollars, or other fiat currencies, but is often calculated and expressed in ETH. 

The NFT market and how to protect against volatility

The market value of individual NFTs varies over time, but the Non-Fungible Token market itself inevitably goes through moments of great expansion and moments of crisis. 

For example, in the past few months, it was experiencing a period of euphoria coinciding with the bull run of the crypto markets in 2021, whereas right now it is in a downturn. 

Those who own NFTs of significant value and want to hedge against the risk of losing market value over time can do so by using various financial products including ETH options and futures.

How do crypto derivatives work

Crypto derivatives have been around for a long time in the crypto space and the market is always very liquid. So it is not at all difficult to find or trade them. 

In fact, the crypto derivatives market is much more liquid than the NFT market, as the world’s leading NFT trading platform OpenSea, for example, trades at a rate of about $70 million a day, while the daily trading volume of crypto derivatives on Binance, for example, is $43 billion. 

One approach that can be used to hedge against losses is futures contracts. Futures contracts allow users to pre-fix the price at which they will buy or sell an asset in the future, so that they can be sure that they will be able to sell it back at a certain price. 

Therefore, people can protect their NFT portfolio in ETH by selling futures at maturity. Generally, futures contracts have an expiry date, so this solution is best suited to those who want to protect themselves against short- or medium-term risks, but not to those who want to do so in the long term. 

Typically, people calculate what percentage of their NFT portfolio in ETH they want to hedge against the risk of impairment by calculating the hedge ratio of their portfolio. After calculating this value, it will be clear how many futures contracts will be required to hedge the risks until they expire.

A similar thing can be done with options, which are derivative contracts that give their holders the right without obligation to buy or sell an asset at a predetermined price. 

These contracts also have an expiration date, so the same reasoning applies as before. Selling operations are called put options, so instead of selling futures it is possible to buy put options. 

Ethereum and the correlation with NFTs

By buying these options, it is possible to sell ETH at a predetermined price in the future, so that any losses in the value of NFTs are offset by gains from the sale of ETH. 

However, it should be added that the NFT market is not perfectly correlated to the ETH market, so these solutions are far from perfect. 

It is therefore not always possible to offset all possible losses in the value of NFTs with gains from selling ETH at a higher price than the market price. In fact, it is a matter of offsetting whose real extent is unknown at the time the derivatives are purchased. 

Another thing to be aware of is the complex nature of these derivative instruments. They are not suitable for all investors or speculators, because before using them, it is highly advisable to find out how they work in order to avoid losses due to errors or misunderstandings. 

Finally, it is necessary to emphasize that these activities are in fact typically speculative, i.e. not suitable for long-term investors, also due to the fact that futures and derivatives have an expiry date. 

Therefore, for an investor who has no speculative ambitions in the short or medium term, they may not be particularly useful, if at all, and may even cause more drawbacks than advantages.