Volare Finance - The Most Advanced Decentralized Option Trading Platform

Updated: 2 days ago


Volare is a Layer 2 enabled DeFI protocol for Vanilla (standardized European options) and exotic options alike, offering a transparent, trustworthy and convenient mechanism that provides option trading without intermediaries. . It is built and led by highly experienced professional option traders, and that experience brought the platform all the features used in professional option trading.. Financial derivatives such as futures have already found their way into the crypto space, paving the way for a proper decentralized option trading platform as a logical next step. Options are the most common type of hedge financial asset accounting for approximately 50% of the whole traditional finance derivatives market. But in spite of their high popularity in the traditional finance sector, the crypto space has been somewhat reluctant to bring them onboard. At this point, there are 4 notable platforms providing option trading: Volare, Opyn, Hegic and Lyra. In addition Goldman Sachs continues to expand its cryptocurrency trading expertise by executing its first-ever over-the-counter (OTC) crypto options trade, drawing a lot of interest and media attention.


What are Options?



According to Wikipedia, in finance an option is a contract which conveys to its owner,- the holder - the right (but not the obligation) to buy or sell an underlying asset or instrument at a specified strike price on or before a specified date, depending on the style of the option. To put it in simple terms, buying an option gives its buyer an option (hence the name) to buy an underlying asset for a pre-specified price on or before a pre-specified date agreed on a contract. Buying an option is done by paying something called ‘a premium’ which is the price of the option. Furthermore, there are only two types of options: ‘call’ and ‘put’. While there are only two types of options, a trader can either buy or sell, which means there are basically four types of transactions. In any given transaction there is always a seller, who writes the contract, collects the premium and has the obligation to sell/buy the stock (only buyers decision is optional), and a buyer who agrees on the contract, pays the premium to the seller and has the option to sell/buy the stock. Picture 1 illustrates this relationship clearly




Another important concept to understand is ‘dependence on style’.. The most common options are American style and European style options. The main difference is that American options can be exercised any time prior to the date specified in the contract, while European options can be exercised only at expiration. It is important to point out that the contract is agreed upon when both parties have different expectations of the future price movement :the buyer of a call option believes the stock will appreciate to or beyond the strike price, while the seller believes it will either trade sideways, not reach the strike price or will depreciate.


Vanilla Vs Exotic Options


Vanilla options are standardized European and American style options. On the other hand, exotic options have more advanced and complex features. As per Wikipedia definition, exotic derivatives may have several triggers relating to determination of payoff. An exotic option may also include a non-standard underlying instrument developed for a particular client or for a particular market. Exotic options are more complex than options that trade on an exchange and are generally traded over the counter (OTC).

In general, as crypto assets are not ‘standard underlying instruments’, any option related to crypto assets could be deemed exotic based on the said criteria. There’s a variety of exotic option subcategories, most common ones listed by The CFI Institute:


  • Asian Options: payoffs determined by the average price of the underlying security over several predetermined periods of time;

  • Barrier Options: only activated once the price of the underlying asset reaches a predetermined level;

  • Basket Options: instead of one underlying asset on the contract, there is a basket of them with specifically assigned weights;

  • Bermuda Options: a combination of American and European options

  • Binary Options: as their name suggests, there are only 2 outcomes - win or lose. The payoff is based on the occurrence of a certain event;

  • Chooser Options: provide the buyer with an additional option to choose at a fixed date (prior to the expiration) whether it’s a call or put option;

  • Compound Options: basically an option on an option, therefore the contract has two expiration dates and strike prices;

  • Extendible Options: provide an option to postpone the contract expiration date

  • Lookback Options: no strike price, but instead, the buyer can select the most favorable strike at expiration time within the lifetime of the options;

  • Spread Options: the payoff depends on the spread of the two underlying assets;

  • Range Options: the payoff is determined as the spread of between maximum and minimum price of the underlying assets within the lifetime of the options.

Why are options important?


Options, as any other derivative products, are mostly used as a hedging tool either by asset managers or companies. Asset managers use them to hedge or reduce the risk exposure of their portfolios, while companies use them to protect their supply chains against sudden price increases. In the crypto space, they could potentially be used by miners to help them hedge against big mining asset price swings - the same potential use case for node operators and even stakers. Options could also prove useful to other parties such as individual traders or investors to achieve either superior returns or hedge portfolios in highly volatile and uncertain times. Investopedia lists the four major advantages of using options as compared to other derivative products:


  • Cost-efficient: options provide great leveraging power, enabling investors to obtain a position similar to stocks positions but at a lower cost. For example (oversimplified for illustrative purposes), purchasing 200 shares of an $80 stock would cost $16,000. By using options, an investor could buy two $20 calls (each representing 100 shares) and gain the same exposure by paying only $4,000 with $12,000 left to use somewhere else.

  • Less-risk (if used properly): simply put, buying options is more cost efficient and that exact cost paid to obtain options is also the limit of the risk. If the investor from the previous example bought $16,000 worth of stocks, his/her risk in case of a catastrophic event is limited to $16,000. A similar portfolio made out of options limits this risk to $4,000;

  • Higher Potential Returns: This property is also derived from cost-efficiency, as the trader can get a higher exposure using options with the same amount of money,thus increasing potential returns.

  • More Strategic Alternatives: options are very flexible, given the possibilities their variety provides.As such, they are one of the best tools to short the market as investors may get charged a margin when attempting to short the market, which can significantly distort returns.

What products does Volare offer?

As stated in Volares’ deck:


“Volare provides a transparent, trustless and convenient decentralized mechanism that runs without intermediaries on options trading. It eliminates the credit risk issues associated with options trading in the over-the-counter (OTC) market in the traditional financial world. Developed to facilitate DeFi crypto options trading while providing trading tools that professional option trades use.”


Their products are divided into two categories - Range A and Range B. In short, Range A is the portfolio of option types which are provided on-chain (all products provided in Table 1), while Range B are professional trading and management tools for option trading activities (all products provided in Table 2).


Table 1. Range A: On-Chain Option Trading products

*Popular structured products that pay a high coupon if the underlying asset passes an upside barrier, at which point it automatically matures and the investor’s principal is returned.

**Option strategies have their basis in simultaneous usage of various Option types to achieve a specific goal. For instance, a straddle is a strategy buying simultaneously Call and Put Options for the same underlying asset, as the trader expects huge price movements in either direction.

*** VIX Index in traditional finance measures the volatility of the broad US market based on S&P 500 index Options. Also referred to as a Fear Index.

****Taking exposure in option trading without having to manage expiries.


Volares’ competitors


At the moment of writing, Volare has three competitors: Opyn, Hegic and Lyra, with Volare taking the lead in most comparisons. Table 3 presents the whole comparison analysis according to Volare’s deck.



Exotic and Vanilla Options


Volare is the only platform providing exotic options for its users, making it the only such platform in the crypto space. On the other hand, all platforms provide vanilla options but with only Volare not requiring 100% collateralization for option writers. A 100% collateralization puts a huge pressure on investors' cash balances, reducing or even eliminating capital efficiency (which is one of the advantages of options). It is also important to note that Opyn, although considered a competitor in vanilla options by Volare, does not actually provide options. According to their website, Opyn provides “global Options-LIKE exposure” - something similar to options, but technically not options.

Table 4 provides an overview of vanilla option competitors. It is obvious that Hegic shouldn’t be considered an actual competitor as: 1) Individuals are able to only buy options and not write them out; (2) The pricing model seems unfair; and 3) Supports only WBTC and ETH options with further limiting them to only 3 Call and 3 put options (10%, 20% and 30% price movement). On the other hand, Lyra could be considered a major competitor - compared to Lyra, Volare still has the advantage of less capital requirement and a potential to support more asset types.


Profit Sharing, Interest bearing Collateralization, AMM, Hedge and Financial Instructions


In respect to Profit Sharing and AMM, those are provided by Volare, Hegic and Lyra. Probably the most notable feature is also a non-listed feature labeled ‘Trade Options through NFT’, which effectively lowers trading requirements for retail investors and boosts liquidity. Options through ERC998 can be traded in OpenSea or similar markets via ERC998.


Potential market reach

As was previously mentioned, options account for as much as 50% of the derivatives market in traditional markets. While the derivatives market in the crypto asset field has a relatively longer history, its importance became visible after December 2020 - since then, the relative value of the derivatives volume increased significantly, and the proportion of spot vs derivatives volume has narrowed. This can be clearly observed in Chart 1. According to CryptoCompare, as of January 2022 the proportion of the derivatives volume compared to spot volume stood at 61.3%, or at $2.9 trillion.


Chart 1. Monthly Spot vs Derivatives Volume

Given the aforementioned high proportion of options in traditional market, it is fair to estimate two scenarios:

  1. The Derivatives volume will not change with a proper introduction of options, but certain traders will migrate towards options. This way options could potentially take 50% of the volume, or $1.45 trillion per month at current levels;

  2. Options could potentially attract more option traders from the traditional markets and increase the total volume of the crypto derivatives market, which could ceteris paribus fade our previous estimation.

With either of these scenarios, Volare is well positioned to take the highest potential market share, as it is undoubtedly the most advanced option trading platform.


Roadmap

2021

Q1 - Volare Project Initiation

Options market research

Project feasibility analysis

Competitive product analysis

|

Q2 - Volare Protocol

Off-chain system development

Contract architecture and protocols

Real-time system to track contracts

Contracts parsing system

|

Q3 - Vanilla Option

Cross-chain trading deployment

CLOB

Sub-second Oracle

NFT option trading

|

Q4 - Option Combo

Index family, community product integration

Liquidation contract and robot arbitrager

Live calculation of collateralization rate

vAMM

Volare token uitility (token profit sharing)

|

2022

|

Q1 - Exotic option, Volatility products

Develop different types of exotic option trading

Structured product issuance based on Volare protocol

Customized option structure by Volare protocol users

|

Q2 - Trading Suite

Financial tools development

Complex structured products combining yield farming, mining, options, etc

|

Q3 - Option on synthetic assets

Synthetic assets (SPX, US treasury, FX and commodity)


Core Team Members


Jake, Head of Product and Capital Markets

Jake holds a PhD degree in Mathematics and has extensive knowledge as an option trader. His work experience comes from major investment banks in New York, where he held a position of an interest rates option trader in both vanilla and exotic options.

Alex, Senior Quant Lead

Alex holds a PhD degree in Applied Math and has 10+ years of experience in developing pricing models for the financial derivatives in Fixed income, Equity, FX and Commodity products. In the past he served as a Vice President in the quantitative analytics department for Barclays Capital.


Kimbol, Head of Risk Management

Kimbol has solid experience as a quantitative risk analyst. His previous work experience includes being a senior quantitative risk analyst in ING Financials, where he was responsible for managing the market risk of ING’s $50bn annuity portfolio which includes different structures of exotic options.


Concluding Remarks




Volare is a very interesting project led by a team of experienced traders and analysts. It is also the first platform to provide complete facilitation of traditional option trading in the crypto field, which includes vanilla and exotic options. In addition, they provide professional trading and management tools for advanced option trading activities. To attract and introduce option trading to smaller retail investors, Volare developed option trading using NFTs, as retail investors are already familiar with NFTs. In our opinion, Volare has no direct competitor as other platforms provide only partial solutions. At the moment, the derivatives market in crypto stands at $2.9 trillion monthly volume, making the market which Volare is trying to address anywhere above $1.45 trillion a month in volume - a conservative estimate. Being the most advanced option trading platform in the crypto field, Volare has a huge potential to capture a large share of the option derivative market.


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Links

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Volare Finance Deck


References:

https://cointelegraph.com/news/goldman-sachs-completes-first-otc-crypto-options-trade-with-galaxy

https://en.wikipedia.org/wiki/Option_(finance)

https://en.wikipedia.org/wiki/Exotic_option

https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/exotic-options/

https://www.investopedia.com/articles/optioninvestor/06/options4advantages.asp

https://drive.google.com/file/d/1ZAGcEJCAi-CYHmwuJ15K8OC-QlAZC3vH/view

https://www.opyn.co/

https://medium.com/hegic/hegic-hardcore-beta-release-2573a2d4cb3d

https://www.cryptocompare.com/media/39501098/cryptocompare_exchange_review_2022_01-1.pdf