Deriverse is a comprehensive derivatives DEX on Solana, offering perpetual swaps, options, futures, and spot trading all in one seamless platform. Designed to provide an unparalleled experience for professional crypto asset traders, Deriverse aims to bridge the gap between traditional and on-chain trading by delivering top-tier tools and features. Deriverse also serves as a permissionless launchpad for crypto assets. It stands out as the only platform that empowers users to create both spot and derivatives markets – including futures and options, fostering innovation and expanding the scope of on-chain trading opportunities.

In this article, we will provide a brief overview of the current state of crypto options on CEXes & DEXes. By crypto options, we mean all option instruments with crypto assets as the underlying asset.

What are options?

Options are financial derivatives (instruments deriving their value from an underlying asset), which give you the right, but not obligation, to buy or sell the underlying asset.

There are 4 main types of options trades:

1. Buy a call option: Get the right but not obligation to purchase the underlying asset at a specified strike price before or on the expiration date. If the asset’s price goes above the strike price, you can exercise the option to buy at a lower price, potentially profiting from the difference. When you buy a call option, you pay the premium upfront, so initially you are negative PnL, but if the price goes up, you have theoretically unlimited upside.

2. Buy a put option: Get the right but not obligation to sell the underlying asset at a specified strike price before or on the expiration date. If the asset’s price falls below the strike price, you can sell at the higher strike price, potentially profiting from the difference. When you buy a put option, you pay the premium upfront, so initially you are negative PnL, but if the price goes down, you have theoretically unlimited upside.

3. Sell a call option: Get the premium upfront, but also the obligation to sell the underlying asset at the strike price if the option buyer exercises the option. This strategy can generate income from the premium received, but if the asset’s price rises significantly, you may have to sell it at a lower price, leading to a potential loss. When you sell a call option, you receive the premium upfront, but have to assume the risk of price going up.

4. Sell a put option: Get the premium upfront, but also the obligation to buy the underlying asset at the strike price if the option buyer exercises the option. This can generate income from the premium received, but if the asset’s price falls significantly, you may have to buy it at a higher price, potentially incurring a loss.

When you sell a put option, you receive the premium upfront, but have to assume the risk of price going down.

Why trade options?

There are 7 main reasons why you would trade options:

1. Get cheap & easy leverage: Let’s say you buy a 1-month SOL call option with a strike price of $200 for 5$ (you pay $5 premium). The current price of SOL is $180. You got exposure to 1 SOL worth $180 with only $5, which equals 36x leverage. You don’t have to pay funding rates (like in perps) or interest on borrowed capital (like in leveraged spot). Most perpetual swap platforms only offer 20x leverage, so you would only be able to get $100 exposure with your $5.

2. Bet on a specific event: Let’s say you expect a major negative event to be announced on Ethereum. Instead of shorting Ethereum and exposing yourself to theoretically infinite losses, you can buy a put option, and in case the negative event does not end up materialising, or the price does not react the expected way, you only lose the premium you paid for the put option.

3. Bet on asymmetrical risk: Let’s say you know SOL will go to the moon in the next 3 months. You can buy a 3-month SOL call option. In case the moon does not materialize, you only end up losing the premium. However, your upside is theoretically uncapped.

4. Earn yield: Let’s say the yield on ETH is 10%. You can buy ETH, deposit it, and earn yield. To hedge yourself, you can buy an ETH put option. As long as you earn more by the yield than you paid for the put option, you have a significantly less risk yield.

5. Go long volatility: Let’s say you are pretty sure the price of BTC will move significantly in the next month. You can buy a 1-month BTC call option and a 1-month BTC put option. If the price of BTC goes over either of the 2 strike prices by more than the premium you’ve paid, you have made money.

6. Go short volatility: Let’s say you are pretty sure the price of BTC will not move much in the next month. You can sell a 1-month BTC call option and a 1-month BTC option. If the price of BTC does not touch either of the strike prices, you have pocketed the premium.

7. Hedge: You can hedge yourself using options in many ways, e.g. with a protective put. Let’s say you bought BTC and expect the price to go up. You can buy a put option to protect yourself in case of the price going down.

Crypto Options Market

Crypto options are traded on centralized exchanges (CEXes) and decentralized exchanges (DEXes). As with other instruments, crypto option volumes on CEXes have been dominating DEXes.

Options on Centralized Exchanges (CEXes)

As with other instruments, crypto option volumes on CEXes have been dominating DEXes. The vast majority of crypto options volumes are made of BTC & ETH option volumes, and are traded on Deribit. Figure 2 shows us that monthly crypto option volumes on CEXes have been on average ca. $60bn in the past year. 80% to 90% have been traded on Deribit. However, Deribit dominance in crypto options trading is slowly falling.

In many cases, crypto options are not traded by clients directly on the exchange, but via brokers.  For example, 40% of all options volumes are traded via Paradex.

Options on Decentralized Exchanges

Volumes on crypto option DEXes have been growing but are only a fraction of DEX volumes. Figure 3 shows us that monthly DEX crypto option volumes have ranged from $1bn to $4bn in the past 6 months.

As per Figure 4, crypto options DEX platforms such as Derive see around $260,000 in daily trading volume, with Aevo capturing $160,000.

Crypto option DEXes have tried to compete with perpetual swaps. Perpetual swaps offer simplicity, easy leverage and exposure to different crypto assets, with a reduced inventory risk, i.e. having to hold other assets than stablecoins on traders’ balance sheets.  However, options are only a small fraction of perpetual swap volumes. This indicates that crypto is still dominated by retail traders, who prefer simple instruments, with no fragmented liquidity over multiple expiration dates.

When it comes to options, there is a difference in notional volume & premium volume. Premium volume of DeFi crypto options, i.e. the amount buyers are paying to sellers of options. Notional volume is the value of the underlying assets covered by the traded options. If the notional volume is much higher than premium volume, this indicates trading of only cheap options.

Option Greeks

The Greeks all measure the sensitivity of an option to various changes in market conditions

1. Delta Δ: Delta is the rate of change of an option's price relative to a change in the price of its underlying. For example, the price of a 50 delta option will move 50% as much as the underlying. An option where the option's strike price is equal to current spot price is known as an at-the-money option (ATM). ATM options have a delta of 50, while deep in the money options have a delta of close to 100. We can also think of delta as probability. A 50 delta option has a 50% chance of expiring in the money. For a call option, the higher price of the underlying goes, the call is more in the money and the delta goes higher. Once delta gets close to 100, odds are ~100% the option will expire in the money.

2. Gamma Γ: Gamma is the rate of change of an option's delta relative to a change in the price of its underlying. When we buy an option, we are long gamma. That means the further in the money the option goes, the faster the option's price will increase. This is also known as positive convexity. We can also think of delta as speed and gamma as acceleration.

3. Theta Θ: Theta denotes time decay. The longer the time frame, the more likely it is that the option is going to hit the target strike price. Therefore, longer term options are more expensive.

4. Vega v: Vega denotes the rate of change of an option's price relative to a change in its implied volatility.

There are other Greeks, such as Rho, Volga and Vanna, but we can leave those for later posts.

How do various trading activities affect the Greeks?

When buying an option, a trader is long gamma (convexity), long vega (volatility), and short theta (time decay). Options lose value as time passes. A trader who is long an option compensates for time decay with convexity.

long options = positive delta

short options = negative delta

Imagine an options seller who wants to hedge his delta exposure. By doing so he becomes delta neutral. Let’s say he sold a BTC call, so he buys BTC to hedge. As BTC price goes up, to remain delta neutral, he buys more BTC.

The options seller is short gamma. The more the price goes up, the more the dealer has to buy to remain delta neutral, generating on the extremes what is known as a Gamma Squeeze.

When selling options, gamma is the key. Or more precisely, the gamma position of those who hedge their delta (mostly options sellers).

long options = positive gamma

short options = negative gamma

When an options seller’s gamma profile is negative, they will buy on the way up, and sell on the way down, amplifying market moves. Conversely, when sellers have positive gamma, they will buy on the way down, and sell on the way up, dampening moves.

negative gamma = big moves

How are DeFi options priced?

When buying an option, we pay the premium. Premium is based on the option’s likelihood to pay off. In the context of DEXes, it is important who (market participants) or what (market mechanisms) decides. There are broadly 4 categories of options DEXes in terms of how the pricing happens.

• Orderbook: Options market makers submit bids and asks into an orderbook, based on their internal valuation models. The interplay between bids and asks in the orderbook dictates the option prices. Examples of DEXes using an orderbook include:

  • Ithaca: Uses off-chain orderbook and on-chain settlement on Arbitrum.

  • Aevo: Uses off-chain orderbook and on-chain settlement on its own chain.

  • Derive: Uses off-chain orderbook and on-chain settlement on its own chain, Ethereum, Arbitrum, Optimism, Base, Mode, Blast

  • Opium: Off-chain orderbook & on-chain settlement on Ethereum, Polygon, BSC, Arbitrum.

Orderbook-based option DEXes rely on matching engines to connect bids and asks, which means they are only possible on high performance / low fees blockchains, such as Solana, or customized L2s.

• AMMs: Passive liquidity providers stake idle liquidity in an automated market maker (AMM). This central liquidity pool acts as a counterparty to all traders, sells options, and pockets the premia + fees paid by option buyers. The price of these options is usually based on a variation of a Black Scholes Merton Options Pricing Model. We can further break down this vertical into Internal & External AMMs.

  • Internal AMM: Protocols utilizing their own AMMs for pricing information. Examples of DEXes using Internal AMMs include:

    • Deri: Uses a single liquidity pool as a counterparty for all trades, built  Optimism and Linea and 8 other chains.

    • Hegic: Specializes in 0DTE (<1 day expiration) options and one-click trading strategies on Arbitrum.

    • IVX: Offers 0DTE options on Berachain.

    • Premia: Offers a hybrid AMM (on Arbitrum One) + orderbook model (on Arbitrum Nova). It is active on  Optimism and 3 other chains.

    • Rysk: Specializes on liquidity pools accessible to orderbook market makers on Arbitrum.

    • Gamma Swap: Used to rely on an external AMM, now using their own internal AMM solution to power the platform.

    Other internal AMM option DEXes include Stryke on Arbitrum and 3 other chains, & Thales, specializing in overtime markets (recently rebranded to Overtime Markets).

  • External AMM: Protocols utilizing 3rd party spot AMMs, e.g. Uniswap or Balancer for pricing information. Examples of DEXes using External AMMs include:

    • Limitless: An oracle-less & liquidation-less solution, offers yield generation for Uniswap LPs.

    Other external AMM option DEXes include Panoptic on the Ethereum mainnet & Smilee on Arbitrum.

• RFQ: RFQ, i.e. request for quote, is an intent-based system. This means that opposed to defining a transaction, a user specifies the intended outcome of a transaction and a network of solvers compete to deliver the best execution of this intent. Examples of DEXes using an RFQ mechanism include:

  • Arrow Markets: Developed an RFQ system on Avalanche.

  • Predy: An RFQ system coming out soon on Arbitrum.

• Other Option DEX Protocols:

  • Structured Products: Investment strategies offering higher returns and lower rewards. When options are sold / written, they are normally sold to market makers. These protocols usually take the short side of the option trade by selling covered calls and puts, thus generating yields. Examples of Structured Products include:

    • Cega: Offers exotic options products with 3 strategies: a) pure options strategy; b) bond plus options strategy; c) leveraged options strategy,

    • Pods: uses yield bearing assets stETH, aUSDC as collateral to buy options,  e.g. protective puts.

  Other Structured Products solutions include Thetanuts (vaults focused on Pendle’s PT tokens), 3Jane (a fork of Ribbon), Strands (tokenization of covered calls) & SuperHedge.

  Other protocols touching DEX options include ClearDAO (offers an options SDK), Jasper Vault, Sharwa, Teal Finance & Umoja.

Challenges of Option DEXes

There are still challenges that need to be addressed in option DEXes, such as:

1. Limited and fragmented liquidity: Because options on a single underlying asset have multiple strike prices and expiration dates, the liquidity gets fragmented, requiring a much more sophisticated approach from market makers when providing liquidity. This level of sophistication is overall still lacking in the options DEX segment.

2. Poor pricing: In order for an AMM-based options protocol to be viable, LPs have to get adequate yields. The pricing mechanism needs to sell options at the correct prices, so that in most cases, the premiums outweigh the potential LP losses from options expiring in the money. AMM-based options DEXes are competing with Uniswap for passive liquidity and need to be able to offer competitive yields.

3. Inefficient margining: Options DEXes mostly offer isolated margins. In order to increase the efficiency of margining, options DEXes need to offer cross-margins, i.e. use traders’ other positions on the DEX to be used as collateral. This increases risks, but increases efficiency, which might be beneficial for some traders.

4. Short maturities: Option expiration times in DeFi options are usually weekly. However, based on evidence from traditional finance, traders prefer to trade options with longer maturities.

In future posts, we will explain how Deriverse is tackling these challenges, focusing on our options AMM and the concept of trading ranges.

Thank you for shaping the future of decentralized derivatives trading with us! Stay tuned for our next article!

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