Can Options Trading Be Used to Hedge against Impermanent Loss in a DeFi Position?

Yes, options trading can be an effective tool to hedge against impermanent loss. Since impermanent loss is driven by price divergence (either up or down) from the initial ratio, a liquidity provider could purchase a straddle (a call and a put option with the same strike price and expiration).

The payoff from the options would offset the loss incurred in the LP position due to a large price movement in either direction. This strategy effectively limits the downside of price volatility while maintaining the yield from trading fees.