Overall Strategy (Advanced)
The DHV will act as a permissionless vanilla options AMM, allowing anyone to buy from the vault or sell to the vault, options at a range of strike prices and expiries. At all times the DHV will be aware of its own position and will price its options in such a way as to incentivize the sale/purchase of options that bring the DHV's exposures closer to 0. Learn more about how options are priced.
During periods of sustained stronger demand in one direction and where the rebalancing incentivisation alone isn't enough, the DHV has a number of external tools it can utilise to immediately hedge delta, in either direction. These include, but are not limited to, buying spot assets on Uniswap markets, and opening perpetual future positions (initially integrated with Rage Trade and GMX). In addition, hedging can also be achieved through a Uniswap range order product allowing us to construct quasi-limit orders. Furthermore, the DHV can also offload large options exposure to other parties via an RFQ mechanism.
Liquidity providers deposit funds to the DHV, which are then used to collateralize the options sold by the vault or to pay for options being bought by the DHV and collateralized by the seller. The DHV collects premiums from traders buying options from the vault and pays out a premium for each option sold to the vault. The corresponding spread between the two forms part of the yield earned by liquidity providers. The vault Revenue Potential for the Liquidity Providers comes from Spread * Volume and the risk can be measured through Inventory Turnover. Rysk model is targeting to turn over option inventory as much as possible since that will decrease risk and increase revenue (assuming the same spread), increasing profitability for Liquidity Providers.
In the case where options bought by traders remain on the DHV's books, they are dynamically risk-managed through to expiry. Statistically speaking, implied volatility is higher than realised volatility. This means that, on average, the cost of delta hedging an option through to expiry is less than the market-price premium paid. Again, the revenue from this statistical phenomenon passes through to liquidity providers. Options can also be purchased by the DHV to help risk manage the book in the case that this statistical observation doesn't hold or too much risk is concentrated around a specific strike and/or expiry.
Although the DHV targets a delta-neutral book position, being delta neutral does not actually impact the overall yield of a trading book. What it does do, however, is greatly reduce the variability in the daily returns. By virtue of keeping delta-neutral, the DHV's daily revenue stream is kept more consistent, adding protection for liquidity provider USDC deposits against the price fluctuations of the ETH/USDC market, leading to the LP token price becoming largely uncorrelated to the rest of crypto. The DHV purchasing options also aids in hedging off positions and reducing the book's short gamma position, this in turn allows the DHV to act as an exchange collecting the difference between the buy price and sell price as profit, aka the spread.