How to trade (buy and sell) options with Rysk
Rysk enables anyone to trade buy (call) or sell (put) ETH options on-chain with a wide range of strike prices and expiry dates.
A Call is an option contract giving the holder the right, but not the obligation, to buy an asset (i.e. ETH) at a specified price (strike price) at a specified time (expiry).
A Put is an option contract giving the holder the right, but not the obligation, to sell an asset (i.e. ETH) at a specified price (strike price) at a specified time (expiry).
The flow to trade options at Rysk:
- Select the expiry
- Select strike and type (put or call)
- Select whether buy or sell and check the premium offered by the DHV (premium will be the price a buyer will pay to buy the option or the price a seller will receive to sell the option)
- Input the number of contracts to trade (1 contract corresponds to 1 option)
- In the case of buying, the buyer pays the premium in USDC (two transactions might be required: USDC approval and trade)
- In the case of selling, the seller decides the asset to use as collateral and inputs the amount. There is a minimum collateral required but each trader can decide the level of collateral based on risk appetite. Learn more about collateralisation here. The seller deposits the amount of collateral decided and receives the premium.
- Once a position is opened traders can close the position by trading back the option to the DHV, or allow the options to play out to expiry and redeem the option, receiving the cash payout (in case of buy) or settle the option, receiving the collateral back (in case of sell).
A long option is when a trader buys a call or a put. The buyer pays a premium (the price of the option) to have the right to buy (calls) or sell (puts) the underlying asset (i.e. ETH) at a specified price (strike price) at a specified time (expiry). While the profits on a long option may be unlimited, the losses are limited to the premium paid.
Traders can buy (long) an option from the DHV by selecting the type (put or call), expiry, and strike price and inputting the number of contracts desired. The premium to pay will be quoted by the DHV as described in Options Pricing. The trader can then complete the trade by approving USDC spending and paying the premium in USDC to buy the option. The position can be closed any time by trading back with the DHV.
As with buying options, traders can sell options to the DHV by selecting the type (put or call), expiry, and strike price and inputting the number of contracts desired. The premium received to sell will be quoted by the DHV as described in Options Pricing. Collateral will be required to sell options. Rysk has a partial collateralisation mechanism in place as described in Collateralisation- traders can use USDC or WETH as collateral.
There is a minimum collateral requirement and traders can decide the amount they would like to collateralise. Once the option is collateralised and sold to the DHV, the associated premium in USDC will be sent to the trader. The position can be closed by trading back with the DHV and the collateral will be released.
Sellers can sell different types of options strategies: naked calls, covered calls and short puts.
Naked Call Option
A naked call is when a trader sells the call option without owning the underlying asset (i.e. ETH) to receive the premium (the price of the option). The payoff of a naked call strategy is the opposite of a long call, the profits are limited to the premium received, while the losses could be theoretically unlimited.
Covered Call Option
A covered call is when a trader sells the call option while owning the equivalent amount of the underlying asset (i.e. ETH). The maximum profit of a covered call is equivalent to the premium received for the options sold, plus the potential upside in the underlying asset between the current price and the strike price. The maximum loss, on the other hand, is equivalent to the purchase price of the underlying asset less the premium received.
A short put is when a trader sells a put option to receive the premium (the price of the option). The profit on a short put is limited to the premium received, but the losses could be unlimited.
It is possible to collateralise calls or puts with USDC or WETH, where the option seller can choose which asset and the amount of the collateral to post. The Seller can choose whether to utilise a fully collateralised position (no risk of liquidation) or a partially collateralised position (with liquidation risk).
As an example, Alice decides to sell a naked call and post 500 USDC as collateral to trade that option. On the other hand, Bob is interested in selling a fully collateralised covered call and decides to use 1 WETH as collateral.
If a sold option is partially collateralised, a minimum amount for the collateral is required, and the position can be liquidated to ensure the system is healthy and sellers can't walk away from their obligation as described in Liquidation.
An ETH call option is considered fully collateralised when there is 1 WETH as collateral, whilst a put option is considered fully collateralised when the amount of collateral in USDC terms is the same as the strike price. For example, an ETH $1500 PUT option is fully collateralised with 1500 USDC as collateral.
When a short position is partially collateralised a minimum amount of collateral (minimum margin requirement) is required to keep the position healthy, and is defined by the collateralisation formula described in Collateralisation. If at any point the collateral value of a position goes below the minimum margin requirement, the position can enter the liquidation zone and the seller can be liquidated.
The partial collateral mechanism allows better capital efficiency. However, it requires extra attentiveness from the seller to protect their collateral and ensure a liquidation event is not triggered.
When a short position is partially collateralised there is a risk of liquidation. The margin safety factor is used to calculate the safety of a position and how close it is to liquidation.
Each position has its own collateral vault, meaning that shorts on different options have isolated the liquidation mechanisms. As an example, Alice is short 10 ETH $1500 PUT and short 10 ETH $1000 PUT. From a smart contract perspective, she will have a collateral vault open for the $1500 PUT with its required collateral and a different, isolated vault open for the $1000 PUT with its required collateral. This means that from a liquidation perspective, each position is independent.
The margin ratio is computed as follows:
- represents the margin safety factor of the collateral vault i,
- represents the collateral held in the collateral vault i;
- represents the minimum margin requirement for the options held in the collateral vault i.
is 1 or lower a collateral vault is considered liquidatable, and above 1 the collateral vault is safe.
A seller should monitor their margin ratio and make sure it's not reaching the liquidation zone. The seller is able to add more collateral to each position to avoid liquidation.
The liquidation is triggered by bots and keepers that can trigger a liquidation when the position is underwater, effectively replacing the seller in their obligations. A liquidation is a punitive event for the seller and for this reason, it is very important a seller is monitoring their position to make sure a liquidation is not triggered.
To avoid a liquidation a seller could decide to fully collateralize the short trade reducing capital efficiency in favour of no liquidation risk.