Introduction

So the first part of this series was pretty well received, I thought I’d press onwards to the other big category of derivatives, options. The options space isn’t nearly as big as the perps space, but I do believe that there is a significant untapped market there - but it’s currently not fully reachable due to a couple of key problems inherent to options (more specifically, permissionless options). In this article I’ll explain what these problems are, the different approaches teams are building to try to address them, and my unsolicited opinions every step of the way.

But options are too complex for the average user!

This is a common take you may have already heard by now - I think it’s valid to a certain extent, but not where it matters most. I do think options require a certain level of understanding to properly utilize, but I also think that you could say the same for a lot of different protocols. Options are simply singled out because we’ve never once had good options protocols onchain, and not everyone has a background in tradfi. Crypto protocols have, believe it or not, already done a great job of abstracting away complexity for users of all shapes and sizes. If we have users who can understand and successfully use protocols like Uni v3, Trader Joe, Velodrome, Synthetix, and many more - there’s no doubt in my mind that we’ll have a significant subset of users who use options onchain one day.

That being, said - I will admit that it can be quite daunting if you’re not familiar with what they are + how they work (and this whole article will be pointless without that prerequisite). So let’s see if we can fill that gap really quickly:

What’s an option?

There are two basic kinds of options - calls and puts. Each one can either be sold/written (this is called going short an option) or purchased (this is called going long an option). An option, like all other derivatives, is a contract dependent on the value of its underlying asset. In this case, an option is a contract that gives the holder the right (but not the obligation) to purchase or sell the underlying asset at a given price (strike price) by a given expiration date. A call entails purchasing that asset, while a put entails selling that asset. Options can be bought or sold - if you’re selling an option, then you’re hoping the underlying asset never breaches that strike price (Out of the money, or OTM) - in this scenario, writers simply claim the premium the buyer paid. If the option does breach that strike price (In the money, or ITM), the seller is then required to buy/sell the asset at the strike price, regardless of what the price of the underlying asset is (or deliver the associated cash position).

Like most onchain perps - chain options can also be cash-settled - which means that rather than the delivery of the asset upon closure/expiry, the protocol will deliver the associated cash position. If you remember from part one; this is quite similar to how perpetual futures work. The key differences are:

• A single options contract is, by its nature, leveraged. As such they don’t necessarily require additional leverage and won’t be liquidated if no additional leverage is used (though, sometimes leverage can be used for writing options)

• Options often have an expiry date on which they will be exercised, while perps are simply exercised at some arbitrary point in the future

  • American-style options can be exercised at any time on or before the expiry date; European-style options can only be exercised on the expiry date

• Options allow for the creation of much more complex strategies than perps. See here for some examples.

Pricing

While I think the complexity hurdle can and will be overcome - pricing is a more complex issue. An options price determines what a buyer pays and what a writer collects to open the trade - a crucial component for determining your breakeven price and overall PnL. The Black-Scholes model is often used in tradfi to price options. The main variable to be mindful of in this equation is implied volatility (IV), which is a measure of the market’s opinion of the underlying asset’s likelihood to change in price. The challenge arises because this is standardized for equities, not digital assets. The traditional model doesn’t apply to token-based options because it wasn’t designed to price such volatile assets. So, when using this equation as is to price options you end up with overpriced premiums. Deribit, the leading centralized options exchange, uses its own proprietary pricing engine (I wasn’t able to find any info on this - I’m guessing it’s not public info) rather than the Black-Scholes model.

Because of this issue + regular inefficiencies with putting markets on chain - you end up with different pricing across different platforms. This can be a huge advantage if you’re a savvy options trader - there are always deals + arbitrage opportunities available as is with any emerging markets. Here’s a cool website that helps to illustrate those differences and to highlight arbitrage opportunities.

I won’t bore you with additional nuance - though if you’d like to deepen your understanding, Investopedia was my go-to source when I was first getting started. You can really fall down the rabbit hole if you’re interested, there’s tons of math + different strategies and approaches to comb through. But for now - this level is sufficient for understanding the protocols we’ll be looking at. So let’s get after it, starting with the current market leader.

Lyra

Lyra offers European-style options trading against $ETH and $WBTC on Arbitrum, and against $ETH, $WBTC, $ARB, and $OP on Optimism. They offer their own frontend but also allow offers integration for other frontends like Kwenta or management strategies for other platforms like dHedge or Toros. Lyra is currently the market leader - employing an AMM-based approach to offer options contracts.

Providing Liquidity

Lyra employs a peer-to-protocol approach where LPs deposit stablecoins ($USDC for Arbitrum, $sUSD for Optimism) into market maker vaults (MMVs) to collect trading fees and market make, serving as a counterparty for all traders. Similar to GLP from GMX, LPs profit from the collective loss of traders - but to protect LPs from greater downside, capital from MMVs can be routed to GMX or Synthetix (perps and spot synth, respectively) to hedge against a particularly one-sided trading environment.

Pricing

Lyra’s pricing engine also increases/decreases IV (and subsequently options prices) based on OI. This way, if demand skews long, traders are incentivized to correct that balance by receiving cheaper quotes on the short side. This system incentivizes a balanced trading environment, with tighter bid-ask spreads supplemented by dynamic IV adjustments and a more delta-neutral LP environment. There are also mechanisms in place to maintain payouts to LPs (and subsequently restrict deposits/withdrawals), a minimum 5% liquid stablecoins in MMVs in case of insolvency, and a way to bypass the deposit restrictions in case LPs are queued for too long while insolvent.

Trading

Traders can write undercollateralized options in either the base (underlying) asset or the quote asset (USD stable). If liquidated, users are forced to buyback their position with the provided collateral (and the position suffers a liquidation penalty) - or you can simply fully collateralize your trade and not worry about liquidation. The system does come with some key limitations for traders though, namely not being able to open positions within twelve hours of expiry, delta cutoff ranges (delta is a product of IV, it represents how sensitive the option price is to price movements in the underlying asset), and forced closure of open trades which violate those first two restrictions (which incurs a penalty). Lyra also offers trading rewards in their native token - these rewards are weighted towards users who pay higher fees relative to premiums, open shorter-dated positions, and/or hold positions until expiry. These rewards can also be multiplied by their referral program or by staking $LYRA - up to 2.5x base rewards. Trading using Lyra on Optimism also yields $OP rewards, though only 30k $OP total, and the program should be wrapping up this month.

Token

$LYRA is the native token of the Lyra protocol. Staking the token allows users to vote on/create new proposals (and subsequently delegate that power), earn a boost to their yield in MMVs, earn emissions (in staked $LYRA), and earn a multiplier for their $LYRA trading rewards. Unstaking $LYRA incurs a 14-day waiting period, during which the staking rewards become disabled. After this 14-day window, a two-day unstaking window opens, during which users will need to confirm their action. If this two-day period passes without unstaking, the tokens will be staked again and subject to the same 14-day waiting period should the user choose to unstake again. I’m not really a huge fan of this - it’s not a common approach and is a pretty significant hindrance to LP UX.

Catalysts/My Thoughts

Lyra is one of the better options we have currently for onchain options. The interface is quite straightforward, the bid-ask spreads seem to be consistently the best, they frequently hit their liquidity caps, and they’re leading in volume + TVL for pure options AMMs. However, their limitations are a pretty decent hindrance for traders, and as a result OI/volume is slightly trending downwards. I don’t expect these leads to be held too much longer, but there are some interesting developments on the backend that could help them remain competitive in a constantly innovating market.

Specifically, Lyra v2 was recently announced. This consists of an OP stack L2 where Lyra will offer perps + options. The waitlist for this product recently opened up, so outside of the few blog posts we still don’t have a ton of concrete information. However, based on the information we do have, Lyra Chain sounds eerily similar to the next contender on our list, Aevo. The only key differences that are mentioned include account abstraction (this is a buzz word until further notice. I’m tired of defi protocols boasting account abstraction support when we’re still far off from consumer-ready implementation) and gas fees accruing to the Lyra DAO (no reason that Aevo can’t also do this). This honestly seems like a last-ditch effort to me - and unless Lyra Chain ends up being sufficiently different from Aevo, I’ll continue to believe so.

Aevo (+ Ribbon)

I think people often misassociate Aevo and Ribbon - it’s important to understand the distinction and how they’ll one day integrate with each other. Ribbon was created first - they coined the DOV (defi options vaults) approach wherein users deposit capital into a vault that runs automated options strategies - in this case two complementary vaults, one that sells covered calls/puts and another that purchases USD bonds via Backed and purchases weekly ETH options (calls or puts) or purchases barrier options (complicated strategy, but basically allows for ETH exposure up to ± 10% of current spot price). These options are all ran via Opyn, which we’ll get to later.

Aevo is a European-style orderbook-based options exchange (and perp exchange, but we’re not gonna get into that too much) built by the Ribbon team - currently running on an app-specific L2 that uses the OP stack. Aevo will eventually integrate with Ribbon, mitigating their reliance on Opyn in favor of offering a comprehensive suite of defi products all within the Ribbon family.

Providing Liquidity

Aevo does not use liquidity providers in the sense that most onchain AMMs would. All trades are settled peer-to-peer like a true orderbook-based exchange would (think dYdX). The liquidity providers are the traders and vice versa - resting limit orders can be seen cleanly on the UI. This means that the presence of market makers and large traders can make a big difference in how much liquidity is available. They offer orderbooks for ETH and BTC options (and perps) as well as OTC trading for ~17 assets. OTC trading uses a RFQ (Request for Quote) system - in which a user requests a trade and Aevo relays that to market makers. Market makers respond with a price and agreement to execute (or quote) and users choose whether or not to purchase/sell at that price. OTC positions cannot be executed early, and must be held until expiry. This isn’t exactly scalable, but allows them to offer options on tail assets ($BLUR, $PEPE, etc.) with notable limitations (inefficient pricing, no secondary markets).

Pricing

In an orderbook-based exchange, pricing is contingent upon liquidity/volume. With something like Lyra, you can count on getting orders filled at the offered strikes using their pricing model - even if liquidity in MMVs isn’t great. With Aevo, in order to get a fill you have to have a direct counterparty for your trade. This leads to gaps in their orderbook, difficulty closing positions early, and wide bid-ask spreads.

So you get a more comprehensive list of strikes compared to AMM-based exchanges, but less liquidity at certain strikes based on market demand. I think this exacerbates the chicken-and-egg problem of attracting liquidity + fair pricing in my opinion. However, I do like the potential catalysts in store to help address this, and don’t see the issue as insurmountable.

Trading

Trading on Aevo, in my opinion, is the closest thing we have to a CEX-like experience in onchain options. You deposit funds once (and pay gas once), and then all transactions are gasless and require no additional approvals (this is because Aevo is paying for gas on their rollup, I don’t expect this to last forever, but currently there’s no timeline for when this will end), very similar experience to dYdX, the leading perp dex. The caveat to this is that withdrawals are estimated to take three hours to process. Trading fees are currently 5bps/3bps (taker/maker) of the notional size with a cap of 12.5% of the options price, a 0.015% settlement fee (when you exercise an option, also capped at 12.5% of the contracts price).

Catalysts/My thoughts

I think Aevo has the most impactful guaranteed catalyst in their future to bring in additional volume/liquidity - Ribbon. Ribbon was the first DOV (Defi Options Vault) project; DOVs are essentially capital management strategies that consist of users one-click deploying capital and the vaults buying/selling options to create complex delta-neutral strategies (or slightly directional, in certain cases). You may remember earlier on when I mentioned options allow users to create complex strategies with more nuanced profit curves - DOVs abstract that process away, allowing users to generate sustainable yield. Ribbon currently runs their vaults using Opyn, but they’ll eventually integrate them with Aevo instead. Ribbon currently has a TVL of ~$30m with plenty of room to grow given vault caps. It’s hard to estimate how much of this volume would feed into Aevo exactly (the Aevo FAQ says $80m weekly, but I don’t buy that given low Opyn volume, a variety of vaults that offer strategies for assets not yet listed on Aevo, and not all strategies being purely options trading), but we can (conservatively) assume that it would increase current Aevo volume by a couple of multiples at least. 

There’s also a snapshot coming in the future. It’s unclear exactly what this would be for - but Discord discussion leads me to believe it’s some kind of airdrop. Whether that’s in $RBN or a new Aevo token, I’m not certain (earlier Discord discussion from a couple of months back led me to believe that there would be no Aevo token, but the tone seems to have shifted).

As an Aevo user, I’d love to see an $AEVO airdrop (remember the $RBN airdrop? They handed out 5 figures like it was nothing). But as a pragmatic researcher, I’d rather see the $RBN token integrated to a greater degree so as to not ostracize those holders/really early supporters by fragmenting across two tokens. With an Aevo integration it also doesn’t make sense to split governance across two tokens given decisions for one platform will often directly affect the other. A migration to a new token with conversion for $RBN holders would be a nice happy medium (not sure how this would be executed without diluting $RBN holders though).

Since I wrote this, Ribbon announced they’d be winding down $RBN tokenomics, launching $AEVO (allowing for 1:1 conversion for $RBN holders), folding Ribbon’s structured products into Aevo’s suite of products, and hosting all governance under $AEVO.

Aevo has honestly been quite dominant since their full launch. They’ve been shipping new products like crazy, leading in options volume, and have no sign of slowing down just yet. I think we’ll be able to easily call Aevo the leader in the current options space in due time. However, the current options space is still small, and a competitor could make their own case for a top spot should they end up capturing new market share.

Dopex

Dopex was one of the first onchain options protocols I’d ever heard of and one of the first protocols on Arbitrum I interacted with. They’ve come a long way since then, and like all other options protocols they still have a long way to go. Out of all the different projects we have here, Dopex probably has the most comprehensive suite of products - including Single-Staked Options Vaults (SSOVs), Atlantic Options, Options Scalps, Zero Day to Expiry Options (0DTE) and Options Liquidity Pools (OLPs).

SSOVs

Single-Staked Options Vaults are Dopex’s main product - European-style options infrastructure utilizing a peer-to-pool model. Options sellers can deposit into an options asset vault of choice (put or call) at a desired strike price in either weekly or monthly epochs to earn yield in the form of premiums and $rDPX rewards (more on $rDPX later). Withdrawals from this vault are locked during the epoch, and can only be withdrawn in full at the end of the epoch (assuming the seller’s option expired OTM). Traders can purchase these options so long as there is sufficient liquidity from sellers in a given vault. Dopex SSOV pricing uses a modified Black-Scholes model that assumes the risk-free rate to be 0, and bases IV on the 30-day historical volatility of the underlying (unless a strike for ETH/BTC directly matches that of Deribit, in that case they take the IV from Deribit).

Atlantic Options

Atlantic Options use a whitelabel integration with GMX to offer straddles (long volatility positions) and liquidation protection. For straddles, users provide $USDC to write ATM puts on a selected asset. This means that LPs need to maintain short put exposure to provide liquidity for Atlantic Options, which denote a bullish bias (collects premium above the strike price, unlimited downside below the strike price). Atlantic Straddle purchasers can then borrow this liquidity to create a long straddle position - 50% of the $USDC collateral is swapped for 1 spot $ETH, which is analogous to a long call position (known as a synthetic long). This leaves the trader with 1 ATM long put and 1 ATM synthetic long call, creating upside as long as price moves sufficiently in either direction. Atlantic Liquidation Protection uses the same put liquidity to provide protection for perp long positions. Traders purchase Atlantic puts which have dynamic parameters to prevent the liquidation of their long positions on GMX (done through Dopex’s UI), allowing the position to remain open in situations where it would normally be liquidated.

Options Scalps

Options scalps are a separate vault that allows for options trading on a very short time frame - between one minute and four hours - with up to 110x leverage. These require single-sided liquidity similar to the above two products but have a premium derived from ATM options with a hard-coded IV and additional interest (18.5% APY) paid from buyers to sellers for limit orders. LP deposits are locked for an hour, after which the LP is free to withdraw at any point. These LP positions are often very risk minimized, “trader profits are paid from the relative appreciation of the swapped asset while losses are reimbursed from trader margin” (doesn’t sound like a very scalable system to me). Traders can then deposit $USDC as collateral to open scalp positions, paying a premium to LPs while doing so. These positions can be opened or closed as desired, so long as there is liquidity.

0DTEs

0DTE options are just options contracts that expire the day of the purchase. Options writers deposit stablecoin or underlying asset liquidity which are used to write options up to 20% out of the money (e.g, if $ETH is trading at $1000, max strike price would be $1200, min would be $1000). This liquidity earns premiums from options buyers and pays settlement should the options expire ITM. The IV for these contracts has a multiplier based on current utilization of liquidity, making premiums more expensive when demand is high and vice versa. Buyers need to specify a long and a short strike price to open a position, paying a premium in $USDC. The long strike price dictates what the price must be above for the option to settle, while the short strike price dictates the price at which price the settlement price will not increase (i.e. where the position closes). This is a spread position - where the user’s profit increases up to a certain point and then flattens at the short strike price.

OLPs

Lastly we have Options Liquidity Pools - these are where SSOV purchases can exit positions mid-epoch against a liquidity pool if they don’t want to hold until expiry. The LPs for this are users who’d like to purchase options mid-epoch at a discount - they select parameters for the SSOV (asset, strike, direction, expiry) and deposit either $USDC or the base asset. OLP users are SSOV holders who view the available liquidity from LPs and can decide whether or not to sell their SSOV position to one of the LPs.

Tokenomics

Dopex has a dual token system with $DPX and $rDPX. $DPX can be locked for up to four years to obtain $veDPX. $veDPX holders receive protocol revenue and emissions in $DPX. The plan is to implement a $CRV-like system where $veDPX holders can vote on directing future emissions to specific options pools/strike prices to drive liquidity, as well as general governance functionality including protocol parameters and new token inclusion.

$rDPX is currently a rebate token - used to compensate options writers for a portion of their losses to help liquidity providers be a bit more delta-neutral. $rDPX v2 however, boasts a whole host of new features. This will consist of a bonding mechanism used to mint synthetic assets, namely $dpxETH - complete with a peg stability module and LP management for a $rDPX-ETH permissioned AMM and perpetual put pool that is used to back $dpxETH. $dpxETH will be initially used to farm rewards from the $dpxETH/$ETH Curve pool and maintain peg(Dopex and partners are actively accumulating $veCRV and $vlCVX to direct emissions), while in the long run $dpxETH will be gradually integrated throughout Dopex for greater options functionality (unspecified how currently).

Catalysts/My Thoughts

$rDPX v2 is the biggest catalyst I have on my radar - besides that I don’t have much reason to be bullish here. If you read through all 5 products AND $rDPX v2 above and your head isn’t spinning by now - props to you. We started off this article by talking about the issue of options complexity hindering adoption; in my opinion, Dopex does very little to address this issue. SSOVs are their main product and relatively simple to use at face value - but doing things like providing liquidity for them risk-free (or close to it - I don’t think $rDPX emissions are a great way to prevent risk for writers) or exiting positions early require the usage/understanding of their other products (not to mention you’re paying fees every step of the way). In addition, creating this many different products - while useful for a savvy user - requires fragmenting liquidity. Let’s take a quick snapshot of liquidity/demand across their products (on July 10, 2023)

Obviously, we wouldn’t see that many 0s if we used a longer time frame than 24 hours - but the point I’m trying to illustrate is that fragmenting across all these different products is rarely a good approach this early on. If I’m looking to day trade options onchain - do I really need a separate product for 0DTE options AND options scalps? If I want to be able to trade options and have a reliable secondary market to exit early if I want to - can I guarantee decent liquidity via OLPs on Dopex? Not to mention the fact that LPing/trading for some of these requires a requisite understanding of both options and the specific product (0DTEs for example, need to understand the profit curve + need for a second strike) Maybe there’s some updates I’m missing here or $rDPX v2 really shakes things up, but I just really don’t see a reason to fragment this heavily - SSOVs have decent demand and UX, I’d like to see everything be more synergistic and usable with that core product. I’m willing to give them the benefit of the doubt for now given they’re clearly a strong team that can make creative products + the fact that v2 will optimize different parts of the product, but for now I’d rather

Hegic

Hegic is a peer-to-pool-based American-style options AMM on Arbitrum and Ethereum, and it’s my favorite case study on this list. I’d never gone too deep into it prior to beginning this research - but I’m quite glad now that I have. Hegic was founded and developed by one person, Molly Wintermute. In my research, I came across her book detailing the story behind Hegic. It’s a long read, but I’d highly recommend it if you have an hour to spare. She talks about her experience being faced with exploits, misinformation, markets, and her long-term vision for Hegic/defi. Enough gushing for now - let’s look at what this thing is today.

Providing Liquidity

Hegic wraps up their liquidity providers, options sellers, structured products, and $HEGIC stakers all into one pool (known as the “Stake & Cover” pool, or S&C). In order to take part in this, prospective LPs need to buy and stake $HEGIC during the first seven days of an epoch (one month). During this epoch, the $HEGIC in S&C is used to collateralize all options + provided strategies done by traders. At the end of the epoch, the LPs receive 100% of the premiums earned by selling options and options strategies. If PnL for the given epoch was positive, LPs simply receive their profits in $USDC. If Pnl was negative, a pro-rata share of $HEGIC tokens is sold to $USDC to cover the net negative difference. The HEGIC/USDC conversion rate is publicly announced five days before the end of a new epoch based on the token price performance in the previous epoch (provided by the Hegic Development Fund, which is funded by Hegic’s own internal options strategies in the Hegic Operational Treasury).

Pricing

Since Hegic offers American-style options - there is no secondary market to sell your open positions. However, you can exercise your position at any point so long as it is in-the-money. As a result, the price of an options contract really only matters when first opening a position - after that, if it’s ITM you can exercise it for its exact value (strike price - spot price for puts, spot price - strike price for calls) while if its OTM it's worthless. The premium at open is determined by an offchain model which varies based on time to expiry + how deep ITM/OTM the strike is. In comparing Hegic’s premiums to that of other protocols, they tend to come in a bit expensive - the lack of a direct counterparty means the AMM is creating quotes for all trades as opposed to any arbitrary counterparty.

Trading

Trading on Hegic is margined in USDC. Hegic’s trading experience is quite different from that of other protocols discussed here mostly due to their experience. Directly from the UI, users are able to open complex strategies as well as standard call/put buying. 10 different multi-leg (multiple options) strategies are available, with a nice display that helps illustrate the nuances of each strategy.

There are also no options to sell calls or puts alone (known as a “naked call/put”) on Hegic - only as part of a specific strategy. Strike prices are also a bit limited on Hegic - for naked calls/puts only four strikes are available per expiry, with one ATM and the other three up to 30% OTM. Hegic also has a rewards program for traders (funded by the Hegic Development Fund) which will run until the end of the year. 600 $ETH was allocated at the start of the program. So long as you have a minimum $1,000 in positive PnL (NOT net PnL, only positive trades are considered), you will accumulate $0.2 per $1 of PnL which will then be paid out at the end of the year in $ETH. This figure scales up with total profit PnL - so you can earn $0.3 per dollar if the total positive PnL is between $1m - $2m and $0.5 per dollar if the total positive PnL is above $3m. Basically, you earn a minimum additional 20% gain for all your winning trades.

Tokenomics

As mentioned above, $HEGIC is used to stake in the S&C pool, collecting premiums + trader PnL (in $USDC). Unlike most other tokens in all of crypto, $HEGIC does not govern the Hegic Protocol. The fundamental value of $HEGIC is solely derived from USDC returns in the S&C pool, which allows you to extrapolate a rough fair value projection for $HEGIC. You can find one such projection here. Past that, there really isn’t too much to discuss about the token - the approach/utility behind it is fairly simple.

Catalysts/My Thoughts

I’m not personally that bullish on Hegic in the long run. It was the first options AMM at the time of its launch and served an incredibly important purpose for the larger space, but right now I can’t find too many catalysts or reasons to be bullish relative to other protocols. That being said, given it is a small dev team + no decentralized governance I can’t say for sure whether or not they’re cooking up something big behind the scenes. In addition - this incentive program sounds very attractive to me. You basically get a 20% boost in $ETH to all your winning trades so long as you hit the minimum $1k requirement. This is the only reason I’d consider using this protocol currently (and even then, you have to account for the fact that some of that 20% is just making up for the expensive premiums you’re paying relative to Lyra/Aevo).

Premia

Premia v2 is another AMM-based options protocol on Ethereum, Arbitrum, Optimism, and Fantom offering American-style options. Premia v3 employs a hybrid AMM/orderbook approach to offer European-style options (will only be launching on Arbitrum to start). Premia is in the process of transitioning from v2 to v3 (Premia Blue), and in my opinion, v3 is leaps and bounds ahead of v2 and even has the potential to compete with Lyra/Aevo (in theory). I’ll be mostly focusing on v3 for that reason.

Providing Liquidity

In v2, LPs have the option to deposit into a call pool or a put pool for any given asset (deposit underlying asset for calls, $DAI for puts). Deposited liquidity is used to fill trades at any given price for that asset’s calls or puts. In v3, LPs can create their own pools for any given strike and expiry (for both calls and puts), allowing them to concentrate their liquidity where they believe it will be utilized most (think Uni v3). For every unit of collateral/options that’s utilized, an equal and opposite order is placed, with the intention of maintaining a more delta-neutral position in the long run (while still allowing for biased LPing via range orders).

For example, an LP could deposit collateral (to place bids for options contracts, or buy orders) or options contracts (to place asks for collateral, or sell orders) within their desired range. As the price of the options contract enters their range, the collateral will gradually be converted to options contracts (or options contracts will be converted to collateral). So long as the price stays within this range, the LP will continue to earn premiums on their collateral/options as they flip back and forth between buy/sell orders. v3 will also offer vaults for liquidity providers, allowing them to automatically run LP strategies to earn yield without having to worry about managing positions.

This comprises the AMM component of v3 on Arbitrum - while the orderbook component takes place on Arbitrum Nova. Market makers can place limit orders on Arbitrum Nova, not collecting any maker fees but rather collecting bid-ask spreads (as market makers do). These orders are still quoted to the same Premia interface on Arbitrum, allowing for even deeper liquidity. The orderbook side of things also allows structured products to easily be built on top of Premia.

Pricing

v2 pricing consists of a BSM-based model, with premiums coming in on the less competitive side compared to something like Lyra or Aevo. This pricing model will be a singular vault in v3, while additional vaults, range/limit orders, and the orderbook will all contribute their own quotes as well - allowing price to converge with demand and (in theory) bringing the bid/ask spread as close to that of Deribit as possible.

Trading

Trading on Premia v3 can come from any one of the liquidity sources mentioned above (range orders, orderbook, vaults, or structured products). Traders will need to pay fees that get distributed between liquidity providers and $PREMIA holders (exact split TBD). Since options are European-style, they can only be exercised at expiry (or after, but the value of the contract is locked at expiry). However, positions can be exited prior to expiry due to the composable nature of their contracts (all options are ERC-1155 tokens) - a feature that is often hard to get right with onchain options. Traders can utilize margin for greater leverage via a margin vault, although these positions are not withdrawable and thus must be held until expiry. There’s a separate vault where liquidity providers can select an asset + deadline for when their capital must be returned and subsequently earn interest paid by borrowing traders. There will also be a reserve fund used to protect lenders from insolvency which accumulates some fees - the amount of capital in this reserve fund directly affects interest rates for borrowers so as to compensate for additional risk.

One key distinction for traders here is that traders can only set market orders. Due to the nature of LPing, a limit order can be thought of as an LP range order at a single tick.

Tokenomics

Premia’s token design also takes a big step forward with v3. In v2, we’ve got a basic ve-token model where $PREMIA holders can lock to receive $vxPREMIA (max 4yr lock, longer lock = more $vxPREMIA per $PREMIA). $vxPREMIA holders receive half of all protocol fees (in $USDC) and receive a discount on trading fees (up to 60% depending on your $vxPREMIA balance, or up to 30% for smart contracts). $vxPREMIA lockers can vote on gauges for specific call/put pools to direct $PREMIA incentives, with a cap on max votes per pool so as to prevent low-volume pool farming. These tokens are emitted to liquidity providers at a rate of about 0.9 $PREMIA per block across all supported chains.

v3 changes start out with a revamped token allocation, with the key differences being:

• Founder tokens have been revested as of January 2023 for 4 years

• The development/liquidity mining allocation has been dissolved with the tokens being split between DAO-controlled and used for options liquidity mining + airdrop for $vxPREMIA holders

The protocol fee model will also be changed, with new parameter for base fees, margin fees, and vault management fees. The base fees will be split 80/20 between $vxPREMIA holders and the Premian Republic (managed by the team for opex/research), while margin and vault fees will entirely go to the insurance fund. Liquidity mining is also drastically changing, with a shift to options liquidity mining. Options liquidity mining (OLM) consists of rewarding $PREMIA call options at a 45% discount to the current market price rather than just receiving liquid $PREMIA tokens. If exercised, the user can buy $PREMIA tokens at a steep discount - the proceeds from this purchase are split 90/10 between $vxPREMIA holders and the DAO. If not exercised, the user will still receive 20% of the options intrinsic value (current $PREMIA price - strike price), though it will be locked for a year. The options can also just be sold on secondary markets at the users discretion. Lastly, 10m tokens have been set aside for current $vxPREMIA lockers - starting off with 2m being distributed pro rata to lockers, vested for a year (snapshot is planned for July 24th, but it will be clearly communicated when it’s coming). The remaining 8m token airdrop will be decided on January 2024.

Catalysts/My Thoughts

Premia, like Dopex, has quite the cult following. You’ll often see low volatility for the token for it’s size, I attribute this to a strong holder base but lack of new interest. V3 boasts the most interesting hybrid model for options I’ve seen thus far, and the OLM model should help the protocol generate additional liquidity/revenue. I’ll have to play around with this once it launches, but for now I am cautiously optimistic about v3.

I recently had the pleasure of speaking with the founders on Exit Liquidity - some interesting bits from our chat together can be found in condensed clips here.

Panoptic

Disclaimer: I am an ambassador for Panoptic. I intended to write about them and completed this section prior to being onboarded as an ambassador. But the revision process did overlap with my start date, so do not some bias is possible.

Panoptic is the only protocol on this list not live yet - but I felt it was necessary to touch base on at least one Uni v3-based product throughout my research. Regular options protocols have a heavy reliance on things like orderbooks, timely liquidations, and pricing. Not long ago, some folks much smarter than I realized that range-based LPing on Uniswap has the same payoff as selling a covered call (selling call options while holding an equal amount of the underlying asset). When you implement lending/borrowing for these positions, you can create a new class of derivatives based on Uniswap v3 positions - allowing for more yield, capital efficiency, and strategies all without reliance on any oracles. Panoptic employs this infrastructure to provide perpetual options - or options without a set expiry date.

Some useful resources for learning more about Uni v3-based derivatives:
- My thread
- Medium Articles from Panoptic’s founder

Providing Liquidity

Liquidity can be provided on Panoptic in the form of Uni v3 LP tokens (these are NFTs remember?) or directly to the protocol in any ratio of two tokens. These deposits are escrowed in the Panoptic pool which can then be lent out to traders to buy/sell options. By providing liquidity on Panoptic, LPs can earn fees as they would normally for LPing on Uni v3 as well as commission fees + spreads paid by options traders on Panoptic. The only (visible) additional risk here is liquidation risk - should liquidators fail to liquidate any positions in an untimely manner, that loss is incurred by liquidity providers.

Pricing

Panoptic has probably the most unique pricing mechanism of all the protocols on here. Since options here are perpetual, we’re missing a key variable in the BSM equation - expiry. Instead, Panoptic has its own proprietary pricing model known as “Streamia,” where a contract only accumulates fees if the price of the underlying asset is within the liquidity range. So you can open a position with a deep OTM strike/strike range and don’t have to pay any premium until the position enters that range. In research this model does converge to the traditional BSM model - but as with any novel mechanism model backed by mathematics and projections, it’s yet to be seen how it performs. A pricing model has to be accurate enough to market demand so that there are always willing traders on both sides of the market - right now it sounds like Streamia is very favorable for options buyers but not so favorable for sellers (in some more extreme cases)

Panoptic hasn’t launched yet, and as such there’s no mention of a token just yet.

Catalysts/My Thoughts

Panoptic (and all the other LP position-based derivatives) still have yet to launch, so the actual launch + subsequent PMF is the biggest potential catalyst. In addition, Uniswap’s recent v4 announcement shakes up the dex space quite a bit - and Panoptic seems to already have been privy to this. The possibilities for v4 are endless, but from Panoptic’s perspective, they’d make the creation of new markets much cheaper, make more complex options strategies more feasible/cheaper, and much more that hasn’t even been thought of yet. The key differentiator here is the Uniswap Labs backing allowing them - anyone can build on v4 but Panoptic may have a bit of a head start as well as a more direct line of communication.

I think the promise of oracleless leveraged trading against any arbitrary pair backed by LP positions is an especially captivating one. I don’t doubt that any one of these products (Limitless, Smilee, Infinity Pools, Gammaswap) could carve out a name for itself in the derivatives market. Panoptic is just one approach out of a handful that I found to be particularly interesting - but as a research/user it’s this class of products that I’m bullish on more than any individual approach (yet, I expect this to change once they begin launching).

Honorable Mentions

Thankfully the honorable mentions list this time around isn’t absurdly long, so I can feasibly spend a bit more time on the ones I find most interesting

Aori

Aori offers an offchain orderbook model where full collateralization of leveraged positions is required. However, the protocol offers a novel margin system which allows for greater capital efficiency when it comes to using leverage (specifically for selling options). The Seaport smart contract suite (Opensea uses this to deploy any NFT marketplace) is used to support gasless order placement. The system is governed by “seat” NFTs, which also provide revenue sharing, 0 fees, and token allocation once they launch the token. The beta should be launched soon - this is one I’ll definitely have on my radar post-launch.

This is another one we had the pleasure of speaking with on Exit Liquidity, clips can be found here. I also contributed to a more in-depth report on Aori here.

Arrow

Arrow uses a peer-to-pool model; the protocol offers Call Spread Options Vaults (CSOVs) where LPs sell options spreads and traders can take either side of the spread (offering Long Butterflies, Call Debit Spreads, and Long Iron Condors). LPs collect premiums and trading fees from traders, and the system has a built-in insurance pool to cover any shortfalls in exercising options as well as hedging with spot on any skewed exposure for LPs. I see this as a split between Dopex and Lyra, but with a bit more complexity. v2 will offer an RFQ system as well as standard call/put buying/selling.

Deri Protocol

Deri is the only protocol in this entire writeup that was also in my perps report, because they’re the only protocol that is actively offering perps and options (yeah I know, Aevo wasn’t offering perps when I did the last report though and Kwenta doesn’t count cause they use Lyra). They use the same market-making algorithm as they use for perps to provide counterparty liqudity + pricing. Just like with their perps, my only interest here is how effective a virtual market-making algorithm can be as a sole liquidity source.

Opyn

Opyn provides options and perps infrastructure using Squeeth. There’s no frontend for this infrastructure, but Opyn provides a couple of vault strategies using the infra - along with Ribbon which currently uses infrastructure (though, this will be moving to Aevo soon). Options are offered in the form of ERC-20 oTokens, which are minted by depositing the underlying asset into a vault to collateralize the option which can then be sold via dexes. Opyn is on its way IMO, once Ribbon leaves I don’t know that we’ll be hearing too much about this one.

Rysk

Some of my friends are airdrop farming this one, but after a closer look it feels too complicated for the average user. Rysk uses a similar model to Lyra, where a vault is used to fund options trading while hedging vault exposure using perps/spot trading. Unlike Lyra, Rysk has an RFQ system for larger traders and MMs to provide liquidity, and a more advanced UX. I quite like the look of it, but I can see how users unfamiliar with options jargon may be turned off.

Wasabi

As with the last one I wanted to include one protocol for options against NFTs - Hook and 0xdx (now shut down) are the only others I know of but Wasabi is my favorite. LPs can sell covered calls or cash-secured puts against dozens of NFT collections which can then be purchased/exercised by anyone. NFT finance has seen quite the downturn in activity recently - I still think this is a super early niche but it’s still one worth keeping an eye on.

This was also one of the first guests we had on Exit Liquidity, full episode here.

Zeta

This is a weird one because Zeta used to be my favorite options dex on Solana. They closed up shop for their options exchange and started offering perps instead early this year. As far as I know, they still have plans to reintegrate options at some point, I just have no idea when. Anyways - as with any defi sector I think it’s worth it to keep an eye on the leading project on Solana within that narrative, no matter how EVM-maxi you might be. Zeta (or maybe PsyOptions) is what I’m watching.