written by Tynan Overstreet
(adapted from the EOSOptions Whitepaper)
One of the most unique features of EOSOptions is the concept of Pseudo-Leverage: the ability to simulate a leveraged position over a finite range of expiration prices.
Pseudo-Leverage eliminates the counterparty risk normally associated with leveraged trading while retaining the desirable properties of leverage, namely the ability for a writer to create more options than they have collateral. In the case of a call option, this is accomplished through the use of a second higher strike price known as a risk cap.
Pseudo-Leverage does not violate the EOSOptions Risk Model as all positions remain fully-collateralized at the outset of the trade.
Let’s take a look at how it works by going through an example below.
Suppose the spot price of EOS-USD is $2.5.
Alice writes 1000 EOS-USD options, a quantity known as the notional amount, with a strike price of $2.5 and an expiration one month in the future. She locks 500 EOS as collateral against these options. Buyers can tell ahead of time that her listing is using Pseudo-Leverage by the fact that the collateral locked by Alice is less than her 1000 EOS notional amount.
The risk cap is equal to:
(Strike_Price * Notional_Amount) / (Notional_Amount — Collateral_Amount).
That means in that the risk cap is equal to
$5.0 = ($2.5*1000)/(1000–500)
It is important to note that in this example, since the option is for EOS-USD, the risk cap limits the max loss of the writer in terms of EOS. This can be seen in the next chart, which plots the intrinsic value of Alice’s 1000 options in terms of EOS:
The lines are the same below $5, but afterwards you can see that the risk cap limits Alice’s max loss in terms of EOS to her initial collateral, i.e. 500 EOS.
This means from a buyer’s perspective, the risk cap is not actually a limit to the amount they can make in terms of stablecoin. Instead, the risk cap is the point at which a buyer’s position ceases to be leveraged.
To see what I mean lets take a look at the same chart of intrinsic value but this time in terms of stablecoin:
We can see that the position is “leveraged” below the $5 risk cap price, i.e. the sensitivity of intrinsic value to price is the same as a 1000 EOS long position. Above the risk cap price, however, the sensitivity of the buyer’s intrinsic value becomes the same as an unlevered position which is long the 500 EOS locked as collateral.
The innovation of Pseudo-Leverage allows the users of the platform to enhance their trade position without jeopardizing the integrity of the EOSOptions Risk Model or having to resort to the use of centralized counterparties or insurance funds. This is powerful because the EOSOption platform retains the benefits of leverage while eliminating the systemic risk that one operator’s over-leveraged position can endanger the entire system.
EOSOptions will deploy in June 2020 to the Kylin Testnet
For detailed information on EOSOptions, check out the full Whitepaper + Roadmap