Call Spread Option Vaults (CSOV)
Call spread vaults allow users to take either side of a call spread. There are two main workflows, corresponding to the two sides of the call spread.
The call spreads are financed by liquidity providers who deposit the underlying at any time of the epoch. The liquidity providers receive a pro-rata share of the profits and losses of the call credit spreads sold during the course of the vault cycle from the moment they have deposited. The liquidity they provide is used to pay out buyers in the event the calls expire in the money.
Buyers can come in and buy call spreads from the liquidity deposited at the prevailing market prices until either the number of available contracts goes to zero or the contracts expire. If the spreads expire out of the money, they lose their premiums. If the spreads expire in the money, the obligations are paid using the deposits provided by the liquidity providers.
Call credit spreads correspond to the short side, and consist of the following option strategy:
- 1.Sell a call option with a certain strike
- 2.Buy a call option with a higher strike
where both options share the same expiration date. Note this option strategy is sometimes also called a bear call spread (see our #TradingThursday thread on it! [Link]). The following diagram summarizes the general profit of a call credit spread at expiration:
The liquidity providers are effectively selling call credit spreads, while the buyers are taking the other side, called call debit spreads. The buyers call debit spread option bundle mirrors opposite of the sellers:
- 1.Buy a call option with strike K1
- 2.Sell a call option with the higher strike K2>K1
where both options share the same expiration date. Note this option strategy is sometimes also called a bull call spread (see our TradingThursdays thread on it! [Link]). The following diagram summarizes the general profit of a call debit spread at expiration:
- 1.Require significantly less capital for collateral, enhancing capital efficiency compared to a covered call strategy, which is the primary strategy behind most other DeFi option vaults.
- 2.Bounded liability for each option spread – liabilities for the writers (vault participants) do not accumulate passed the second strike
- 1.They are cheaper than outright long options while still providing attractive upside potential and thus still benefit from embedded leverage
- 2.There is less at risk as the upfront premium paid is the maximum loss