By FreeMoney
Some of the first businesses to accept bitcoins as payment were online services like VOIP and web hosting. These businesses tend to have low marginal costs and can take a chance on the changing value of bitcoins without putting their operation at risk. Other businesses willingly expose themselves to the fluctuations and actually consider part of their purpose to be converting the operator’s dollars into bitcoins. But as more businesses with varied models start to accept payment in bitcoins they may want to explore possibilities for limiting their exposure to currency movements.
The simplest method for avoiding currency risk is to convert any bitcoin revenue to local currency as soon as possible. However this is not always feasable; payment may be made after goods or services are delivered or funds may be held in escrow. Bitcoin accepting merchants presumably see the benefits of the Bitcoin system and expect it’s value to rise; selling all coins immediately gives up this expected gain.
Buying put options may be a good solution. A put option gives the buyer the right, but not the obligation, to sell an asset at an agreed price at or before an agreed time. A put option can be used as insurance on the dollar value of bitcoin holdings. If the market price drops below the strike price of the put the buyer exercises the option to claim the locked in price. The merchant can count on a guaranteed minimum USD income this way.
Many merchants have been changing their prices, often in real time, according to the BTC/USD exchange rate. A put buying merchant has the ability to commit to a price because he has a rate locked in. This may be attractive to customers. It can make a webstore easier to manage; each customer will not pay a different price for the same item which may be confusing in the case of refunds, for example.
For this protection the put buyer pays a premium. Since there is not yet an active bitcoin options market this premium is unknown. There are some variables that have a predictable effect on the premium. Choosing a strike price farther below the current price will give a discount. This is like accepting a larger deductible on an insurance policy. Choosing a put with a shorter time to expiry will tend to cost less. Higher bitcoin price volatility will make puts more expensive and more stable prices will make them cheaper, but this is out of the control of individual participants.
If puts near the current market price are too expensive merchants might consider selling a call option with a higher strike price and the same expiry as the put they wish to buy. This combination is called a collar. A collar reduces the upfront cost in return for giving up some upside potential. Selling a call gives an obligation to deliver bitcoins at expiry so it might not be wise to do this on the mere expectation of bitcoin income.
When people come to the market they are looking to satisfy their own needs; in doing so they are part of a process that reveals information to everyone. Tools like options can meet merchant’s needs better than simple trading in many cases. Likewise, options allow preferences that would otherwise remain hidden to be accounted for in market prices. Market prices that better reflect reality make planning easier for everyone and this leads to more and better businesses. Active options markets will be a boon for the Bitcoin economy.