DeFi Option Vaults (DOVs), AMMs & Options Selling

Selling & trading crypto option volatility has never been easier given the growth in popularity of DOVs and AMMs. My friend, Darius Sit of QCP Capital and others have written interesting pieces on the rise of DOVs (link & data from the article below).

Is this increasing trend of option selling by passive (retail) capital going to usher in a new era of lower volatility (vol) in crypto markets?

Well, if this growth of total value locked (TVL) in DOVs and AMMs continues to grow at the speed that they are, then it is quite possible this could mean a lower overall crypto volatility base over time. We have plenty of evidence of this from the traditional markets where structured vol selling products offered to retail users on equity indices & single stocks caused equity vols to trend downwards. When there were spikes in vol, they were quickly sold aggressively, as the large bank’s trading desks knew that there was always a continuing supply of volatility that would hit the market on a daily basis via their retail networks.

What are DOVs?

DOVs are a DeFi method of selling option vol and have become very popular in 2021 and will no doubt continue to grow in 2022 & onwards. With a DOV, an option seller, whether they be a call or put seller, creates a vault for the token that they want to write (sell) options on and the DeFi platform then uses this collateral as the fully backed option sell and matches it with a vol buyer. With over $700m in total value locked (TVL) it’s most certainly an innovative product in crypto.

DOV Platforms and Total Value Locked (TVL)

Advantages of selling volatility via DOVs?

  • Highly customizable in terms of the underlying you can sell options on as currently you can only really trade options on BTC/ETH & BCH on the major CeFi exchanges.
  • Accessible to retail or passive capital traders as you don’t need to be an accredited or eligible investor to access these DeFi platforms.
  • 15–50%* yields currently as not only do you collect the options premium but there are also platform tokens airdropped as incentives and staking opportunities for your LP token or collateral (flexUSD for example) which creates a potential triple yield income source.

Disadvantages of selling volatility via DOVs?

  • Even though vault creation is DeFi, the actual option selling strategy is centralised by algorithms.
  • Some platforms are very unclear as to the method used to determine strike prices and terms agreed with the options buyer.
  • Sometimes it’s hard to find much back data on the returns.
  • They are currently inflexible on expiry dates and are typically only monthly in duration
  • Outside of vanilla call or put sells, more complex options strategies are not easy to do, for example, call or put spreads, butterflies etc.

What are these DOV platforms called?

There are many in existence and a few more being launched in 2022. Some of them are:

  • Ribbon Finance
  • Thetanuts Finance
  • stakeDAO
  • Arrow Markets (on Avalanche)
  • Friktion Finance (on Solana)

AMM+ as an alternative way of selling volatility?

Given that the execution of these options strategy are centralised and sometimes opaque, CoinFLEX’s AMM+ retains some extremely attractive alternatives as an option selling strategy:

  • Futures markets are way more liquid than options markets (CeFi or DeFi) and so can soak up way bigger positions than DOVs.
  • Its way clearer as to the strategy being deployed to generate these yields as AMMs (automated market makers) are increasingly being understood and growing fast in both DeFi and CeFi, either on Uniswap V3 or CoinFLEX.com.

Other centralised ways of selling volatility?

  • OTC (over the counter): accredited or eligible counterparts (ECPs) can bi-laterally trade a range of different underlyings and option strategies with large OTC option houses like Galaxy, Genesis, Blockchain.com, QCP, Cumberland & others.
  • CeFi exchanges like Deribit and Bit.com: centralised exchanges remain a great venue to trade options. The major downside being that the range of underlyings are extremely limited with currently BTC and ETH dominating and the only other products being offered being BCH and soon SOL.

Summary

In the traditional markets, trading options have historically been very difficult to access as you tended to have been an institution or eligible counterparty to be able to directly trade on centralised venues like CME, Eurex or SGX. Robinhood has simplified and made this an everyday investment tool for retail traders and with the issues around payment for order flow aside, it has nevertheless been a leap forward for options trading.

The wide proliferation of different ways of trading or using options in crypto is hugely encouraging in taking the base level from traditional finance and taking it into the new financial paradigm of direct market access for all, whether you are passive or active capital.

There are a number of ways to access the options markets if you want to trade:

  • Vanilla options as a highly institutionalised investment house you could trade on CME or could trade on sophisticated offshore exchanges like Derribit or Bit.com.
  • DeFi options as a seller using DOVs.
  • Synthetic options as a seller using Uniswap’s V3 product or CoinFLEX.com’s AMM+.

Crypto users now have a wide variety of options, forgive the pun, to trade and in particular sell derivatives. Looking forward to the continued innovation & growth in this space.

Links:

*https://qcpcapital.medium.com/an-explanation-of-defi-options-vaults-dovs-22d7f0d0c09f

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