Downside protection

Protecting against falling prices

Alice bought 1 ETH at $500 a few months back and the asset has performed strongly since then with current price standing at $3‘500. While she still sees a lot of upside in ETH and wants to participate in it, she also wants to start protecting some of her USD gains. In particular, she wants to lock in a price of $3'000 per ETH.

Alice would like to create a position that increases in value and thereby neutralizes the loss in her ETH holdings as ETH/USD drops below $3'000. The protection mechanism is illustrated below:

An example strategy to limit the downside of Alice's ETH holdings using short position tokens

⚙️ Pool configuration

To achieve her goal, Alice creates a contingent pool with following configuration using the DIVA App:

Example configuration of a downside protection position using the DIVA App.

🤝 Sell long position tokens

After creating the pool, Alice sells all 3'000 long position tokens minted for a total of USDC 2'700 to Bob and keeps the short position tokens.

💵 Payoff scenarios

1) ETH/USD >= $3'000:

• Alice paid a protection premium of USDC 300 (3'000 initially deposited and 2'700 received back due to the sale of the long side) and didn't receive any payout from her short position as the price stayed above $3'000. -> net loss for Alice: USDC 300 -> net gain for Bob: USDC 300

2) ETH/USD = $2'000:

• Alice paid a protection premium of USDC 300 and received USDC 1'000 from her short position -> net gain for Alice: USDC 700 (neutralizing the loss in her ETH holdings) -> net loss for Bob: USDC 700