Decentralized Options Vaults (Part 1)
(Nothing in this article should be taken as investment advice. This views discussed below are for entertainment and research purposes only.)
Earning Yield (The non-degen way)
If, like me, you are a certified cynic masquerading as a realist, you probably believe the ponzinomics used by most DeFi protocols cannot be sustainable, and you would be right. Option strategies are a tried-and-true way to earn a yield on assets. Like anything else in life, they come with risk, but far less risk than the aptly named "degen pools" that most of you seem fine with using. I have conversations with [redacted] guys every week (family offices, funds, HNW) and I can tell you with certainty they are not comfortable with the risk, inflation schedules, and the sheer volatility which most of us have become so accustomed to. Options, however, make sense. DOV's in my humble opinion will be massive, not for what they are right now, but for what they are about to become. Just about every type of structured product built in the [redacted] world can be built crowdsourcing liquidity via vaults, and I suspect that's exactly what's about to happen.
Over the last 6 months I have written extensively about Option strategies and their mechanics on multiple accounts via twitter dot com. Yet I still have friends who don't understand what I'm talking about. I have failed as a teacher. So in a last-ditch effort to create useful content I've decided to write a long-form piece that will hopefully illuminate the ideas I have failed to convey previously. In the following paragraphs, I will attempt to explain what a covered call is and how to earn 40% APY using this strategy via Decentralized Option Vaults.
The Strategy
Covered Calls (CC) are a strategy as old as options themselves, but until now they have been out of vogue with crypto retail. This is somewhat due to them being low on the degenerate scale, meaning "lower" APYs and much lower risk than parking your money in a pool with a random food name yielding 8,000%. Lately, however, I have noticed a resurgence in interest; this is probably due to DOVs (Decentralized Option Vaults) springing up on L1s across the board. But before we get into that, let's briefly review how a covered call works.
I'm sure you all know how Calls work by now but amuse me as I briefly recap. To buy a call you must pay a premium, the seller of that Call collects the premium. As the seller of the Call, if the underlying asset's (i.e., Bitcoins) price is below the strike you sold at the time of expiration, you simply keep the premium. If you are the buyer of the Call you forfeit the premium to the seller. Let's consider a simple setup.
BTC current price: $43,200.
Long 46k Call: $1,100-ish (meaning you bought the 46k Call and it cost $1,100).
Option Expires in 15 days.
If Bitcoin decided to stay under 46k when your Call expires, you would lose the $1,100. (As shown in the graph above.) However, if Bitcoin is trading anywhere above 46k, the seller is obligated to sell you 1 bitcoin for the agreed upon strike of 46k.
For example, if Bitcoin's new price was $50k at the time of expiry, you could buy 1 Bitcoin for 46k from the seller and sell it on the open market for 50k, netting you 4k (minus the original $1,100 you paid for the Call.)
Let's look at this from the seller's perspective. If Bitcoin is trading anywhere below 46k at the time of expiry the seller will simply keep the $1,100 premium and the contract will dissolve. If Bitcoin trades above 46k -like in our example above- they would need to buy a Bitcoin on the open market for 50k and sell it to the buyer of the Call for the agreed-upon price of 46k, netting the seller a 4k loss (minus the original premium collected).
Seller Perspective
1. Seller sells 1 Call at the strike of 46k.
2. Option expires with Bitcoin trading at 50k.
3. Seller must buy 1 Bitcoin on the market for 50k.
4. Seller must then sell Bitcoin to Buyer of Call for 46k (strike price).
5. Seller Net: $-4k.
The payoff curve of the 46k seller below.
Now that we have a loose grasp on how Calls mechanically work, let's dive into executing a CC. First, we want to be the seller of the contract, and second, we need to be holding 1 spot Bitcoin; this is important, and I will explain why in a moment. First, let's break down the steps.
Buy 1 BTC.
Deposit your 1 BTC on an Option Exchange.
Pick your Strike price (In our case it was the 46k Call).
Sell one 46k Call for $1,100.
We know if Bitcoin stays under 46k we keep the premium of $1,100, which is about a 2.5% return in two weeks. Ideally, with a covered call, we want Bitcoins price to remain the same so we can comfortably collect our premium.
Not bad, but what if Bitcoin went to 60k? Well:
Long 1 #BTC: 60k (New #BTC price) – 43k (your theoretical BTC entry) = $17k USD profit.
Short 1 Call: 46k Call (strike price) - 60k (current #BTC price) = $-14k USD.
17k-14k= $3k in USD terms.
So why would you not want to use this strategy? Just by looking at the math above, it's clear you would have come out ahead had you just held BTC (17k vs 3k). Secondly, you need to think about what might happen if the price of BTC plummets. You will keep the premium you collected ($1k) but it might not be enough to offset the losses on your spot Bitcoin. Of course, the importance of this all depends on whether you are denominating your portfolio in BTC or USD.
DOVs
If you are at all interested in using a CC to collect yield on your stagnant boomer coin, you have a few options. First, if you live outside of the U.S., you can easily deposit a Bitcoin on Deribit and sell the Call at the strike you are interested in, done. But that requires KYC and a few other inconveniences, for example you only have the option to sell Calls on BTC, ETH, and soon Solana. For those of you either unable or unwilling to deal with centralized exchanges, there is another way.
Decentralized Option Vaults (DOV) have exploded onto the scene over the last few months and protocols like Ribbon, Dopex, Friktion, Katana, Tap, Thetanuts and many more have manifested from the ether to meet the Call (pun).
"In December, options protocols grew TVL by 86% while the entire DeFi TVL actually contracted by -1.5%. Over the full quarter, options protocols expanded TVL by 412% compared to the 278% growth in DeFi TVL."- Messari Report
Imagine, you are a fresh doe-eyed pleb, straight from tik-tok, not yet battle-hardened and still optimistic about life, you probably don't own any boomer coin yet. But you might own DPX, or SOL, or even LUNA and you're probably thinking you want to collect a little yield on your beloved tokens. If that's the case, all you need to do is deposit them in their corresponding vaults.
(If you are a battle-hardened vet who has had their soul crushed numerous times and that last paragraph sounds ridiculous to you, I assure you, it's not. I've met many a GenZ who think Bitcoin is worthless. What can I say, the future is bright.)
Dopex Vaults
Friktion Vaults
You can see the Solana vault is earning 46% APY at the moment.
Once deposited, the protocol themselves will sell the CC using your deposit as collateral so there is no need for you to bother yourself with learning about Options at all, what a waste of time, right? Not quite, there are nuances across different protocols, for example, you can choose your own strike on Dopex, if you don't know what a strike is, or how volatility works, you are probably going to get hosed. While the vaults do make using Options very simple, I suggest knowing how anything works before you actually throw money at it. (Not Investment Advice)
Maybe you understand options and want to participate in the future of France. Using the vaults, as I said, has made it so easy even Schiff could figure it out.
Connect your wallet to the desired Dapp (Dopex, Friktion, Katana, etc.).
Deposit your tokens in the desired vault.
Let the interest auto compound.
Quit Job, and look for an Island to buy (Obvious joke, do not do this).
Something of note, all DOV's are not built the same. There is a complexity in pricing options beyond the scope of this article, I don't think all teams are up to the task. I suspect many building in this niche will eventually blow a vault or two, so DYOR before trusting anyone with your coin. Also, when locking up your tokens, they are locked for a week, or until the Epoch ends. If a crash were to occur, you are stuck my friend, get that crayon out and start filling in your application for a job at Wendy's, McDonald's is probably too good for you.
Conclusion
I think I am going to end it here, but in the second part of this article I will explain the impact Options and DOV’s are having on the crypto market itself. The vaults might not be perfect in their current form, but this isn't their final form. That being said, they are pretty dang cool. We are seeing the beginnings of a sustainable and complex financial future that anyone can participate in, unless you are from America or North Korea, I wish that was a joke.
I think eventually Options become king, much like in the traditional markets, and I for one shall go hard preaching their utility and proselytizing to no-coiners until they capitulate and buy my bags.
Wen part 2?