The DeFi ecosystem is growing at a breathtaking pace. Unsurprisingly, staying on top of everything in the space is becoming practically impossible. DeFi is becoming increasingly sophisticated each day as the building blocks or rather money legos fall into place. Most people can tell you the basics of spot and margin trading, but I’ve started to see more and more people admit they know are unfamiliar with options trading. And, that’s okay because as many will tell you being a fan of DeFi often times means being a student. We’ve teamed up with folks behind ACO to explore how options fit into DeFi and how you might take advantage of options in your trading strategy. ACO is a decentralized non-custodial options protocol created by Auctus.
What is an option?
If you’re not familiar with the term, options are financial derivatives that offers the option contract holder the opportunity to buy or sell an asset for a specific strike price within a specific time period. In other words, a “call option” contract gives you the option to buy an asset at a given price before it expires by “exercising the option” as it’s called. A “put option” allows you to exercise the contract and sell at the strike price before the expiration date. Options are different from simply purchasing the underlying asset because you only pay the contract premium initially until you exercise the contract, allowing traders to hedge risks or trade with more leverage at a lower capital cost.
This is what makes options different from spot trading or even future contracts: you have no obligation to exercise the contract thus buying/selling the underlying asset. If the trade wouldn’t be in your favor, you can simply let the option contract expire and only be out the premium you paid to purchase the contract. On the flipside, the individual who wrote that option contract earns that premium if it expires without being exercised.
What is ACO?
ACO is a decentralized non-custodial options protocol that allows users to trustlessly trade, mint, and exercise call and put options. ACO protocol tokenizes put and call options contracts creating ERC20 tokens which you can send, trade, or even integrate ACO Tokens into other DeFi projects. Each ACO token option has its own smart contract programmed with the terms of the option contract. Additionally, these terms are also included in the ticker symbol of the ACO token.
ACO tokens’ symbols consists of four parts:
- Symbol of the underlying asset
- Strike price & Strike Asset
- Option type, either P or C, for put or call
- Expiration
Take for example: ACO ETH-200USDC-C-26JUN20-0800UTC
The above symbol represents a call option on ETH, expiring on 26 June 2020 08:00 UTC, with a strike price of 200 USDC.
Auctus, the team behind ACO, has deployed an interface ACO.finance that allows you to mint, manage and trade ACO tokens (which powered by 0x protocol). ACO Protocol and the interface have been audited by OpenZepplin. More on ACO protocol in a bit, but first let’s explore some of the ways ACO option tokens are utilized by DeFi users.
How do I trade options in DeFi?
Now at this point, I’m sure you’re itching to see how you might take advantage of options. Let’s take a moment and break down a few situations where options could be a useful tool in your trading strategy.
Use Call Options to speculate on rising ETH prices
If you expect the price of ETH to rise, you can purchase ETH call options to take advantage of leverage, gaining positive exposure to ETH with less money than outright purchasing ETH at spot prices.
Let’s assume ETH is currently trading for $400. You could buy 100 ETH for a total of $40,000 and be completely exposed to the price of ETH. Or, you could buy 100 ETH calls with a $400 strike price for $8.00 and have a similar exposure but do so with only $800 ($8 X 100 = 800).
I’m sure you can see how this is advantageous. If the price goes up as you expect, you’ll be able to break even at $408 (the strike price $400 + the $8 premium). However if the price of ETH goes sideways or falls, you might be able to sell the option for a loss (less of a premium) or you can simply let your contract expire without exercising it and only be out the money you spent on the premium.
Use Put Options to hedge against declining ETH prices without limiting your exposure
If you aren’t confident in the market and want to protect yourself ETH’s price falling, you can purchase ETH put options to hedge your bets without selling your ETH or losing your potential upside if the price rises. You can think of ETH put options as a form of insurance which costs you a premium to cover potential losses.
If ETH is currently trading at $380 and you want to protect yourself against it falling below $360 but don’t want to sell your 100 ETH quite yet. You could buy 100 put options with a $360 strike price for $4 and pay $400 to have the ability to sell your 100 ETH at $360 if the price of ETH were to drop before your options expire.
Options tend to give you more time to make a decision when compared to stop orders which are final once filled. Unlike a stop order, you can always wait to see if the price rebounds in your favor.
Earn income by writing options on ACO
As previously mentioned, you can write options contracts and potentially earn a premium on any unexercised contracts. Needless to say, signing a contract to buy or sell an asset comes with its risks. As a writer of an option, you may be obligated to sell your underlying asset at the strike price if the holder exercises the contract. We urge you as always to do your own research and to take into account these considerations before writing/minting your first option.
Write ETH Call Options to earn income on your ETH
Say you have ETH that you’re willing to part with for the right price. Using options, you can receive money today for your willingness to sell your ETH at a higher price.
Say ETH is at $380, you could mint and sell 100 ETH call options with a $420 strike price at a $9 premium and collect $900 on your willingness to sell your ETH. If things go sideways or your option expires before being exercised, you get to pocket the premium and keep your ETH. Of course, you’re still exposed to the price of ETH and will be obligated to sell the your ETH at the strike price if your option contract is exercised by the holder.
There a plenty of factors to it for sure but I think you can see how in right situation writing ETH call options could be a way to capitalize on a sideways or bear market.
Write Put Options to earn income on your USDC
Do you have USDC on the side waiting to buy ETH at a price below the current? You could earn a little extra income by writing and selling ETH put options.
Let’s assume ETH is currently trading for $380. You would like to buy 200 ETH if it drops to $300. You could write 200 ETH puts with a $300 strike at $4 and collect $800 on your willingness to buy 200 ETH at $300. Unlike setting a limit order, options let you collect money today for being willing to assume the obligation of buying ETH at the strike price.
By using this strategy, you can generate additional returns in your stablecoin holdings by collecting a premium for your willingness to be obligated to buy a ETH at a price that is below current price.
ACO Protocol and its use of money legos
Many aspects of their design make ACO Option Tokens a nice addition to existing money legos, but its the team’s use of existing money legos to create new functionality that I found the most fascinating.
Flash Exercise
This is by far one of the coolest parts of ACO. ACO has a feature called “flash exercise” which, as its name eludes to, allows you to cover the cost of exercising your ACO options using Uniswap V2 flash swaps leaving you with the remaining profits. Uniswap V2 flash swaps let you withdraw tokens from Uniswap’s reserves as long as you pay back the tokens in the same transaction. ACO’s flash exercise makes use of this by withdrawing the tokens necessary to exercise your options contract and then repaying the withdrawn tokens by swapping the underlying asset all in one transaction.
Net Profit = Number of Options * (( Uniswap Price – Strike Price ) / Uniswap Price )
Essentially, you can always exercise profitable options contracts in one transaction even if you don’t have the funds available to buy/sell the asset before expiration. This opens the door for traders who might want to greater exposure with less funds.
Governance
Currently, the ACO protocol allows a single address to modify parameters, create new options series, add new strike assets and change the template for tokens that will be created in the future. The admin key which controls this address is currently administered by the Auctus team. However, the team plans to ultimately transition control to holders of their AUC token. Once launched, the governance dashboard and system which will allow AUC holders to decide which assets should be supported by the protocol and what fee percentage should be charged and used to buy back and burn AUC.
One key aspects of the current design which you may have noticed is that these parameters only affect future ACO option tokens. The protocol’s admin key has no ability to affect existing tokens, only you have access to your funds and all contracts are exercised in a non-custodial fashion.
Coming up on the roadmap – YFI, Chainlink, and more
YFI put and call options will be added to ACO within the next few weeks. Options will open the door for new strategies for the yearn.finance community. Auctus eventually plans to release an ACO OTC platform allowing users to trade customized options p2p, allowing greater variations of strike prices and expiration dates.
One of the next crucial components for ACO as a platform is the addition of an automated market maker (AMM) for ACO tokens. The AMM would provide option contract holders, whether it be a trader or a smart contract, with constant on-chain liquidity for ACO Tokens.
To further improve decentralization, the team is also looking to create volatility oracles with Chainlink.
Concluding thoughts
Watching DeFi mature has been exhilarating. As each building block is produced, you can see some things like options coming from a mile away. But, I can tell you I didn’t see something like flash exercise coming. It really goes to show how innovations build on one another so quickly in this space.
Thanks for reading! We hope you learned a thing or two. We encourage you to go check out ACO.finance and the slick options trading platform they have built there. You can also learn more by reading the docs or joining the Auctus Discord.
Disclosure: This post is part our DeFi Pulse Drops promotional series; We’ve been paid by ACO to inform readers about why one might use options and about their decentralized non-custodial options platform. As always, we’re committed to providing the entire community with quality, objective information, and any opinions we express are our own.
