DeFi & Options
ATLANTIC STRATEGIES: ATLANTIC STRADDLES
Expecting volatility but unsure of the direction? Dopex's so-called "Atlantic Straddles" are an excellent little product for just this scenario!
Sometimes you wake up and think to yourself “wow, Mr. CEO, let’s go out there and have the best day of your life touching grass”. Next thing you know your intern comes out the gates left-right swinging with another wall of text.
Less typing, more rubbing my dear Intern.
Bla bla bla. Atlantics. Bla bla. Straddle. Bla bla bla.
Righteo, let’s get into it, Students!
For those unfamiliar with how Atlantic Options (AO) work, I highly recommend you go through the Atlantic Options Explainer (which has not yet been released kekLMAO). As per usual, I will summarize the main points below.
AOs are a new type of SSOV where the option writer’s collateral can be borrowed by the option buyer. To prevent the option buyer from purchasing an option and running away with the option writer’s deposit, the collateral can only be borrowed under specific circumstances. This means that the process is typically directly integrated into a partner DeFi protocol - this could include GMX or Vesta where AOs can offer automated liquidation protection.
Buying an Atlantic Call (AC) gives you access to the underlying token. If this is an ETH Call, this allows you to borrow ETH.
Buying an Atlantic Put (AP) gives you access to the underlying stablecoin. If this is an ETH Put, this allows you to borrow stablecoins.
Oh? What’s that? You want to buy AOs directly via so-called “Dopex”?
Well, my pretty pet, Dopex will also be offering our own products that make use of the power of Atlanteenis…
Exhibit A Atlantic (Long) Straddle is shown below.
A long straddle is an option strategy that allows you to profit from price volatility. Typically, building this position requires buying both an ATM call and an ATM put. With Atlantics, you only need to buy an Atlantic Put (AP) and use the stablecoin collateral to purchase the underlying to generate the same exposure.
This is just one of many option strategies that allow you to profit from volatility. Another strategy is a long strangle where you buy an OTM call and OTM put which will create a different payoff diagram but is still a bet on volatility.
Paying one option premium is less than paying for two option premiums which is what we call an “exceptional deal” in the business world.
Before jumping into how the process will play out, have a look at this payoff diagram for an ETH long straddle:
The use of this is quite straightforward. If the price of ETH is sufficiently volatile in either direction, this is a profitable trade. If the price of ETH is stable, you may end up losing money since you pay an option premium.
The breakeven point of this strategy is a price movement of 11.04% in either direction.
Is this likely to happen in the span of an AP term? I refer you to this one week price graph of ETH and will allow you to draw your own conclusions.
R.I.P., my sweet prince.
For those Students whose interest in this proverbial long straddle strategy is satiated by the beautiful payoff diagram above, feel free to stop reading here.
For those that would like to join The Most Esteemed in a journey through how the model is derived, take my hand and let’s go on an adventure.
As a brief rundown of how this strategy will work, we will:
- Buy 1 ATM ETH APs with a strike price of $1500
- Borrow 50% of the collateral ($750 USD)
- Use the $750 borrowed to purchase ETH
Purchasing the ETH AP means that you profit if the price of ETH goes down in exchange for a premium. Purchasing the ETH means that you profit if the price of ETH goes up. Putting the payoff from these two positions together, will give you the diagram above.
This product will be available on the Dopex front-end and the process will be completely automated. Note that whilst you must post collateral to borrow stablecoins from an AP for liquidation protection strategies, no collateral needs to be posted for the Atlantic Straddle.
Super simple stuff.
As per usual, this strategy will be accompanied by a beautiful spreadsheet. Feel free to plug in your own numbers and see how it plays out.
1. Purchase ETH AP
The first thing to do is purchase ETH APs with a $1500 strike price. Let’s put this bad boy into our beautiful Black-Scholes Pricing calculator and see how much the option premium is.
$82.81 to pay?
I will allow it.
Next we need to see what the payoff will be as the price of ETH changes.
Puts give you the option, but not the obligation, to sell an asset at the strike price. This means that as an AP buyer, you will earn from option settlement if the strike price is greater than the spot price of ETH.
2. Borrow 50% of the AP Collateral and purchase ETH
Next thing to do is to borrow 50% of the underlying stablecoin collateral associated with the AP you have purchased. Since your option value is $1500, you will be borrowing $750 in stablecoin collateral.
The Atlantic Straddle strategy will automatically conduct the borrowing and use the $750 to purchase ETH.
For the sake of simplicity, we will be assuming that the funding fee is 0% - in reality, it will likely hover around 5-15% per year.
Net PnL is quite straightforward. If ETH goes down in price you make a loss whilst if ETH goes up in price you make a profit. Since your ETH exposure is 50%, the profit and loss relative to ETH price movements is halved.
3. Putting it all together
Now that we have both parts of our strategy, let’s put the net settlement/PnL together and see what it looks like. As a gentle reminder, we have:
- Purchased an AP: This is in profit if the price of ETH decreases
- Bought ETH: This is in profit if the price of ETH increases
Incredible. We have successfully produced a so-called Long Straddle strategy!
“Mr. CEO, a splendid strategy. But how much does the price need to change for me to breakeven?”
Wow. I have taught you very well, my dear student.
To breakeven, the Total PnL must equal the Cost of Premium which was $82.81. Since we are doing a long straddle strategy, you will see that there are actually two ETH prices which causes PnL to intersect with 0, meaning we have two breakeven points!
Whilst the above graph does a decent job for those that don’t mind eyeballing breakeven points, it has been fully broken down below.
All in all, the price of ETH must move by 11.04% in either direction for this strategy to break even. If the price of ETH moves by less than 11.04%, then the cost of premium will be greater than your payout from the long straddle.
My god… our poems get more profound every week!
CEO (Chief Education Officer)
I SPY WITH MY LITTLE EYE SOMETHING BEGINNING WITH ‘B’
Dopex is a decentralized options protocol that aims to maximize liquidity, minimize losses for option writers and maximize gains for option buyers — all in a passive manner. Dopex uses option pools to allow anyone to earn a yield passively. Offering value to both option sellers and buyers by ensuring fair and optimized option prices across all strike prices and expiries. This is thanks to our own innovative and state-of-the-art option pricing model that replicates volatility smiles.
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