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DeFi Option Vaults
DeFi Option Vaults (DOVs) are the first Automated Investment Product (AIP) to be released on Spin. The release is planned for Q1 2023.
DeFi Options Vaults (DOVs) are instruments that simplify option investment strategies by allowing participants to stake their assets in a vault while earning yield simultaneously. The DOV automatically deploys staked assets into specific options strategies, a process entirely run by smart contracts.
Options strategies provide good yield, but employing the strategies without DOVs can be tiresome. Investors need to calculate premiums, strike prices, suitable dates to position buys or sells, etc. With DeFi option vaults, all the user has to do is stake their assets in the protocol while the protocol invests the staked assets in options strategies on behalf of its users.
The Spin DOVs are one-button automated investment strategies that allow to:
- Invest in selling call and put options through a vault (option sellers) and earn options premiums;
- Buy call and put options through an auction (option buyers) and earn on asset volatility.
There are two main strategies in DOVs: Covered Call and Cash-Secured Put.
A call option represents a right to buy an underlying asset or contract at a fixed price at a future date but at a price that is decided today.
A put option is the right to sell an underlying asset or contract at a fixed price at a future date but at a price that is decided today.
But in case of cash settlement method there is no real transfer of an underlying asset, trades pay out in cash at expiration, rather than delivering the underlying asset or security, and Spin uses this type of settlement.
ITM means “expiration in the money”, and in this case, the option buyer can get some profit from his option. For example, if the NEAR call option strike is $2.5 and the expiration price of NEAR is $2.9, the option buyer can exercise it and get a $0.4 profit.
OTM, on the contrary, means “expiration out of the money”, and in this case, the option buyer can’t get any profit from his option. For example, if the NEAR call option strike is $2.5 and the expiration price of NEAR is $2.1, the option buyer can exercise the option but he will get nothing.
An auction on Spin is the process of selling options created by Vaults to buyers. When an auction starts, all options that were created by the Vault are put up for sale, and their number depends on the number of assets invested in the Vault. Buyers place bids, and after the end of the auction, the buyers who placed the best (highest bid) buy orders receive options in exchange for a premium, which goes into Vaults as a yield for investing.
In practice, Cash-Secured Put and Covered Call strategies have similar risk profiles though there are some nuances. The table below shows the user’s profit depending on the strategy and market conditions.
As you can see, the most aggressive strategy is to hold the underlying asset rather than invest it in DOV. In the event of a sharp rise in price, it will bring more money compared to all other strategies.
The Covered Call strategy is less aggressive, while the Cash-secure put strategy is a rather conservative strategy.
And the most secure strategy is to simply hold stablecoins because there is no profit or risk in this strategy.
DOVs are similar to a very common strategy in traditional markets.
Investors sell options that have a fairly low probability of exercising ITM. This means that investors receive a premium and lose nothing. Strikes are selected in such a way that the probability of ITM expiration is less than 5%.
However, there is still a risk that due to market conditions, the options will be exercised by ITM. In this case, the Vault will have to pay the buyers of the options, and this will lead to losses for investors, so such strategies carry some risk.
Each Epoch lasts 7 days. It starts at 9 AM every Friday when the previous epoch ends.
Users can apply to deposit or withdraw assets to/from the Vault at any time, but assets will only be placed/withdrawn from the Vault at the beginning of the next epoch.
Assets, deposited by users are used as collateral for writing and selling options.
Shortly after the start of a new Epoch, auctions begin. Each auction is a way of selling options to buyers who bid on the options, and the winners buy the options according to their bids. The number of options is equal to the amount of the underlying asset in the Vault. For example, if the NEAR Vault has 1,000 WNEAR, then 1,000 WNEAR options will be available in the auction.
At the end of the auction, the highest bidders receive options and pay a premium for them. This premium represents the return to the Vault investors.
At the end of an epoch, options expire. The expiration price is defined as 30 min. the time-weighted average price of the underlying asset provided by the oracle. Depending on the expiration price, option buyers either get nothing or receive a payout equal to the difference between the strike price and the expiration price multiplied by the number of options.
- Wednesday, 20.12.22 15:30. User A deposits 10000 WNEAR in option Vault.
- Friday, 23.12.22 8 AM. NEAR price = 1.5 USDC. Spin defines NEAR Call option strike and min. option price for the first epoch. Strike = 2.5 USDC, min. option price = 0.03 NEAR.
Epoch 1 starts:
- Friday, 23.12.22 9 AM. 10,000 vtNEAR are minted for User A representing his share in the NEAR Covered Call vault. 10,000 NEAR Call options with 2.5 USDC strike are minted.
- Friday, 23.12.22 9:30 AM. Epoch 1 auction starts. User B places a bid to buy 5,470 options at 0.087 NEAR per option, he deposits 0.087*5470=474.067 NEAR to the auction. User C places a bid to buy 5,500 options at 0.073 NEAR per option, he deposits 0.073*5500=403.33 NEAR to the auction.
- Friday, 23.12.22 9:40 AM. Epoch 1 auction finishes.User B receives 5,470 options at 0.073 NEAR per option.User C receives 4,530 options at 0.073 NEAR per option. (5470+4530)*0.073=733.33 NEAR premium goes back to the Vault.
- Friday, 23.12.22 9:45 AM. Option buyers claim the remaining funds back from the auction.User B claims 72.933 NEAR.User C claims 71.133 NEAR.
- Monday, 25.12.22 14:32 PM.User D submits an application to deposit 5,000 WNEAR to the Vault. His funds get a pending deposit status.
Epoch 1 finishes:
- Friday, 30.12.22 8 AM. The expiration price of NEAR is defined at 2.6 USDC, and expiration takes place. After the expiration options are settled by the buyers.User B profit: (2.6-2.5)/2.6*5470=210.38 NEARUser C profit: (2.6-2.5)/2.6*4530=174.23 NEARSpin defines the NEAR Call option strike and min. option price for Epoch 2. Strike = 3 USDC. Min. option price = 0.04 NEAR.
Epoch 2 starts:
- Friday, 30.12.22 9 AM.User D's 5,000 WNEAR is transferred from a pending deposit to an active deposit.4,831.5154 vtNEAR are minted for User D, representing his share in the NEAR Covered Call Vault.User A has 10,000 vtNEAR equal to 10348.72 WNEAR.15,348.72 NEAR Call options with a 3 USDC strike are minted.