Options are a trading product that can be used to bet on market direction and profit from volatility. Options can offer superior risk-adjusted returns, such a product is an important source of return generation in TradFi, especially in equities, however, it can be difficult to use options trading correctly because it is complex.
It is important for DeFi’s growth to offer access to traditional financial instruments, but it is very costly and time consuming to build and innovate on these instruments. The infrastructure surrounding them must first be built, and this infrastructure must be incentivized. Structured products such as DOVs can help with this. DOVs are prepackaged investments linked to digital assets that can be customized to meet different risk-return metrics. They can take many forms, but at a basic level, they have a risky, return-generating component.
DOVs facilitate this task by offering products that simplify the process and allow users to access implied volatility without having to know much about them. This has resulted in a considerable increase in LTV around products created to meet this demand.
BUT, WHAT EXACTLY DO THE OPTIONS CONSIST OF?
Basically, options represent an agreement between two parties to trade an asset at a specific price before a future date.
There are two types of options:
➖ Call options: Buyer pays a premium for the right to BUY the asset at an agreed price.
➖ Put options: Buyer pays a premium for the right to SELL the asset.
DOVs can be used to improve performance or adjust market positioning. However, they can also lead to negative returns if the market moves against the underlying strategies. The main types of strategies that can be used with DSVs are covered call options and cash covered puts.
COVERED CALLS
If you sell a call option on an asset you own, you are protected if the value of the asset goes up. This is a good way to make money in a neutral or slightly positive market.
CASH COVERED PUTS
The investor sells a put option, which is a contract that gives the buyer the right to sell the asset at a certain price, and sets aside the capital needed to purchase the asset at the strike price. If the price of the asset goes up, the investor keeps the money from selling the put option. If the price of the asset goes down, the investor can buy the asset at the strike price and keep the difference.
HOW DO THEY WORK?
The traders first have to deposit either the tokens that will be underlying the call options or stable currencies for put option sales into special vaults. After enough collateral has been gathered, the options are then auctioned off to market participants. Finally, after the options have expired, the original depositors can withdraw their funds.
Well, now that we have seen how the options work, let’s review some of the most prominent protocols that offer them:
Ribbon is the pioneering options protocol in this industry. Its flagship product, Theta Vault, allows users to earn returns by executing an automated European options selling strategy. Ribbon offers 12 different vaults across 6 different tokens for option selling strategies and covered calls. They went public in April 2021 on Ethereum and have expanded to Avalanche and Solana.
⚫ Dopex
Its main product, Dopex Straddles, works as follows: This is a strategy where you buy both a put and a call option for the same stock, with the same expiration date. This is usually done when you think the stock price is going to go up or down a lot.
⚫ JonesDAO
JonesDao is a native Arbitrum protocol that is built on top of Dopex. Jones’ vaults are managed by the team and are not yet decentralized, which allows for more complexity but avoids mistrust. Most of the collateral is used to earn yield by issuing covered calls. Depending on the market environment, a percentage of the funds are used for hedging purposes.
⚫ StakeDAO
StakeDAO is a company that started out as a performance aggregator like Yearn, but has since expanded to offer other services. Their vaults focus on ETH and BTC, and operate similarly to Ribbon. In addition to the usual covered buy and sell strategies, the protocol also offers an ETH Black Swan hedging vault, which buys ETH puts on a weekly basis in case the ETH price stagnates.
There are other popular protocols such as Opyn or Cega, which we have not broken down in this article, as they are somewhat more complex to analyze and explain.
In summary, options are somewhat complex products to understand, the underlying mechanics that compose them make it necessary to study in depth every aspect related to them in order to understand how they work. DeFi option vaults, on the other hand, are a great example of how to make a complex product more accessible to users. There are many protocols for different options vaults. Some are more complex than others, but all of them allow users to customize their strategies. DSVs also play an important role in the industry by offering real, organic performance. It is amazing to see, as DeFi evolves, how products are being added that until recently were only available from TradFi.
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