Liquidity Providers
By depositing stable coins in the Liquidity Pool, earn passive yield from option writing for both call and put options.
LPs (Liquidity Providers) can deposit funds at the start of each epoch and withdraw funds at the end with no fees attached.
At the end of a trading round (epoch) they will receive the net profit/loss of the AMM (Automated Market Maker)
Writing Call and Put option contracts
LPs deposits are held in a liquidity pool. The moment a trader decides to buy an option contract the liquidity pool either
In the case of a SPY call option contract will mint synthetic SPY using the Synthesizer ensuring covered calls. The liquidity pool will also have the job to maintain the collateralization ratio as the price of SPY fluctuates.
In the case of a SPY put option contract liquidity will be locked at the option strike price ensuring cash-settled puts.
Writing Covered Calls, a radical advantage from traditional markets.
To write a covered call option in traditional markets the writer must hold the underlying asset. Let's take two scenarios and compare them to our approach.
Traditionally
The writer sells a call and locks the underlying asset. If this contract is exercised in the money the writer pays the option holder. Overall the underlying asset rose in value.
The writer sells a call and locks the underlying asset. The underlying asset price falls drastically and the contract expires worthless. In this scenario, the writer did not have to pay the option holder, yet his locked underlying asset dropped in value and if he was to sell, he would sustain a loss.
Our approach
By minting synthetic assets and maintaining the collateralization ratio when selling a call, if the second scenario was to occur, the moment the contract expires worthless the synthetic asset will be sold back to the liquidity pool along with the collateral to mint the asset, so even if the underlying asset drops severely, the liquidity pool will not suffer a loss.
However, if scenario one occurs there can be a risk. To maintain the underlying asset rising in value, the liquidity pool must contribute stable coins to keep the collateralization ratio safe. If there is no liquidity in the liquidity pool and asset prices continue to soar then the underlying assets will be liquidated.
Although this shows our covered calls exhibit traits of naked calls, we prevent liquidation by enforcing strict over-collateralization and a security vault that covers collateralization if liquidity pools dry up.
Minimizing Exposure to Derisk LPs
There are two approaches to minimizing exposure.
Distributing risk
Traditional option writers occasionally suffer huge losses with contracts exercising deep in the money. By pooling liquidity, liquidity providers can share risk and prevent unlimited downside (naked calls).
Dynamic fees paid by option holders
After calculating the net vega exposure in relation to the liquidity pool, trades that increase vega risk have higher fees than those that decrease vega.
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