In this section, we will delve deeper into the pricing and hedging mechanisms of the options created by the Arrow AMM, providing a comprehensive overview of how the platform works.
The Arrow Markets protocol implements a base layer for the pricing, transfer, and settlement of European options. The core protocol is based on an options automated market maker (AMM). The AMM solves the problem of low liquidity in decentralized derivatives markets by transforming liquidity from the underlying market to the level of the option contract. However, the AMM takes on the risk of settling options on its book. Hence a key component of the base layer is an automated hedging engine. In this section, we describe the pricing and hedging of the options created by Arrow's AMM.