Options trading has become more popular than ever now that anyone can trade from anywhere with a few taps. The barriers to entry have been lowered improving accessibility for the average joe. In case you don’t know, options are financial primitives that give a trader the choice (or the option) to buy or sell an asset at a predetermined strike price at some point in the future. Traders can utilize options to hedge against potential price changes or to speculate on the future price of an asset. As DeFi matures, on-chain financial primitives like options become the building blocks for even more sophisticated financial instruments.
If options trading is what floats your boat, say ahoy to SIREN, a decentralized protocol aiming to carve out a unique market niche by catering specifically to sophisticated users interested in holding and actively trading tokenized options contracts. This nautical-themed on-chain options marketplace launched its alpha release in December 2020 and is about to embark on the next chapter of its journey. SIREN Markets is set to launch on mainnet March 1.
SIREN Markets offer seamless on-chain options trading
SIREN is a decentralized protocol which facilitates a marketplace of fully-collateralized, on-chain options. SIREN protocol tokenizes both the long and short sides of an options contract as ERC20 tokens which enables options to be traded via its AMM design requiring no third-party settling mechanism or order matching to complete option settlement on chain. Siren AMM v2 can trade up to 6 SIREN options contracts which all share collateral and payment assets in a single pool. This enables liquidity to be rolled over when a market expires for a seamless UX for liquidity providers.
It starts with liquidity providers depositing collateral into the SIREN AMM pool. So for the WBTC/USDC calls the collateral asset would be WBTC. When you as a trader go to buy options from the AMM, the collateral held within the pool is used to mint a pair of tokens: bToken and wToken. bToken, which stands for buyToken, is sent to the buyer and gives the holder the right to purchase or sell the underlying asset at a predetermined strike price. While wToken, short for writeToken, stays in the pool. If the option is left unexercised, wTokens allow the holder to withdraw the collateral or withdraw the exercise payment from the contract after expiration.
Note, that SIREN AMM v2 only trades bTokens, but not wTokens. Although, the Siren team has stated that trading of wTokens may become available in the future. Users pay a premium to the pool in the collateral asset each time they make a trade. This process results in liquidity providers passively becoming covered option writers, automatically underwriting contracts to meet demand from traders. In addition to collecting premiums, liquidity providers benefit from any slippage in AMM trades and earn SI token rewards from the SIREN Liquidity Provider Program (LPP). It’s always worth noting the risks associated with providing liquidity.
Giving sophisticated options traders the right tools for the job
The tools that options traders have come to rely on in traditional finance were refined over decades and decades. So it only makes sense that these early days of DeFi provide ample opportunity to incorporate and innovate on these tools. SIREN’s design allows traders to easily swap options in and out in order to build complex positions as well as the necessary information to assess those positions.
SIREN AMM v2 pricing is time-decay-aware
There are two factors that determine the price of each trade on SIREN v2: spot price and slippage. The spot price is determined using a Black-Scholes model, which takes into account parameters like the underlying price, time to expiration, option strike and implied volatility, coupled with a Chainlink price oracle. Utilizing this formula allows Siren Markets to be time-decay-aware requiring no arbitrage in order to quote reasonable prices. Similar to other AMMs, trades will be impacted by slippage based on the size of the trade and available assets in the pool. In other words, the larger the trade relative to the size of the pool, the higher the slippage. This slippage ultimately benefits liquidity providers as another source of returns for liquidity providers on top of collecting option premiums.
What is ITM, ATM and OTM?
These expressions are likely familiar to options traders so we’ll skim through these rather quickly. For more in-depth info, you can refer to Investopedia’s definitions. An ITM (short for ‘in the money’) option which has value because it has a favorable strike price compared to the current market price. As you can probably guess, an OTM (short for ‘out of the money’) option still needs to reach its strike price whereas an ATM (short for ‘at the money’) has reached the strike price.
These terms help determine what kind of options traders buy or sell taking into account how that option might behave in the current market. For example, an ITM call may require a smaller rise in the cryptocurrency price to be profitable, but there is less potential upside compared to an ATM or OTM call. So if you believe the market price is going to rise significantly, you might consider buying an OTM call because you’d have a greater potential upside while limiting exposure to loss if the price fell.
These are just a couple examples of the ways traders can make use of different option characteristics to influence their trading strategy. Greeks are another way options traders can assess an option.
Meet the Greeks
As Siren is meant for experienced options traders, we’re only going to give a brief overview of how option Greeks apply to Siren Markets. To get caught up to speed, you can learn more about these general concepts here.
Delta
Delta measures a ratio comparing the difference between the underlying asset price relative to the strike price of the option. The delta of a long call is positive; the delta of a long put is negative. The delta is reversed for short calls and puts. Delta is only a theoretical approximation of your exposure in the underlying asset.
Gamma
If you imagine delta as the “speed” of your option position, gamma is the “acceleration.” The gamma of long options, calls or puts, is always positive; of short options, always negative.
The more gamma your position has, your position delta can change a great deal and probably needs close monitoring. Gamma is highest for the ATM strike, and slopes off toward the ITM and OTM strikes.
If you think the price of an underlying asset is about to change quickly, you want to buy an option with relatively high gamma. For example, the higher the gamma, the more delta if the underlying asset price moves the way you want it to, and vice versa.
Theta
As touched on before, Theta measures the rate of decline in the value of an option due to the passage of time sometimes referred to as time decay. No one can escape time, not even options. Time decay describes how long calls and puts have negative theta, losing money as time goes on. Short calls and puts are the opposite having positive theta and making money as time passes.
Theta is highest for the ATM strike, and slopes off to the ITM and OTM options, and responds to the passage of time and changes in volatility the same way that gamma does. The theta of options is indirectly proportional to gamma. When gamma is big and positive, theta tends to be big and negative. That’s the trade-off. A position that has a lot of gamma (good for fast changing underlying assets) also has lots of theta that is continuously eroding its value.
Vega
Vega is how much the value of an option changes when the implied volatility of that option changes. Long calls and puts both have positive vega and profit when implied volatility rises. Inversely, short calls and puts both have negative vega and profit when implied volatility falls.
The more time there is until expiration, the higher the vega is for an option. Vega also depends on where the price of the underlying asset is relative to the strike price of the option. Like gamma and theta, vega is highest for the ATM options, and drops for the OTM and ITM options. So, ATM options with lots of time to expiration are the most sensitive to changes in implied volatility.
SIREN Governance
The SIREN Market project was created to bring the features and tools options traders are familiar with from traditional finance to a seamless on-chain experience without sacrificing autonomy. The Siren team understands that a platform built to cater to sophisticated users only benefits from their feedback and collaboration. And so, SIREN’s native token SI is designed to reward early users placing the future of the platform in their hands via protocol governance. Liquidity providers, traders, and market makers will receive SI token rewards in exchange for their participation. By design, the most experienced and knowledgeable users will be given the most influence over the platform to help respond to future market demands.
The SI community will be able to create new option markets and determine the fee rate for writing, closing, and redeeming an option. These fees accrue to SI token holders; although it should be noted that upon launch these fees will be set to 0 to reduce the friction for users looking to explore SIREN Markets.
The first SIREN Liquidity Provider Program (LPP) began in December 2020 and was extended through May 2021. Find out more about SIREN’s SI token and liquidity providing program here.
Roadmap
Looking toward the future, SIREN’S roadmap details many future upgrades to the platform like expanding the list of available asset pools. SIREN is considering adding SUSHI/USDC, UNI/USDC, YFI/USDC, LINK/USDC pools starting with Sushi. Even further out, SIREN protocol will be modified to allow yield-generating assets to be used as collateral.
Other improvements which option traders may want to keep their eye out for include future interfaces for constructing option spreads and effecting basket trades natively. SIREN also plans to explore layer 2 solutions to improve efficiency and lower fees for its users.
Concluding Thoughts
DeFi is disruptive because it gives everyone access to the same tools and data as the experts. Many users who had never had never previously owned a share in a company or a treasury bond are now active participants in a new financial paradigm. With the increasing popularity of options trading in traditional finance, it stands to reason that on-chain options may play a bigger role as DeFi reaches more widespread adoption.
It boils down to: Do you desire a more sophisticated options trading experience? If so, SIREN would like to invite you to join them in building a platform that suits your needs. This is an opportunity to influence the platform early in its development. SIREN Markets is set to go live on mainnet on March 1, 2021. If you want to know more, we recommend joining SIREN’S Telegram or following them on Twitter.
Disclosure: This post is part of our paid promotional DeFi Pulse Drop series; We’ve partnered with SIREN to help educate and inform the community about Siren Markets. As always, we’re committed to providing the entire community with quality, objective information, and any opinions we express are our own.
