Covered Calls

Summary
In a covered call strategy, a user would deposit an underlying asset (e.g. ETH, BTC, BNB). Thetanuts would sell a call option to market makers on behalf of the user to generate a premium (paid in the same underlying asset).
"Covered" in this instance is derived from the fact that the option is fully collateralized by the underlying deposited assets. This ensures zero liquidation risk.
Example: For a WBTC-covered call option, users would deposit their WBTC assets into the option vault and receive premiums in the form of WBTC tokens. 
To learn more about how covered calls work please read: The Basics of Covered Calls​
Who uses covered calls?
Covered calls are ideal for a user who wants to accumulate more of the underlying asset and holds the market view that the price of the underlying asset is moving sideways or downwards during the duration of the sold call option. 
Auction parameters
Thetanuts runs 6-10 delta weekly strategies for ETH and BTC based on prevailing market rates with reference to Deribit.
For all other tokens, Thetanuts sets the strike at 25% above spot for bi-weeklies. If the yields are too low, for instance in a period of low volatility, Thetanuts will adjust the strike closer to achieve a 6-10 delta return. 
Strikes are selected based on these parameters at 0900 UTC on Fridays, when auctions are conducted.
Understanding the risks and rewards
There are 3 main scenarios when considering using the covered call strategy. To illustrate these scenarios, it is assumed that the initial price of ETH is $2,500 and the user has deposited 1 ETH into an ETH-covered call vault. The strike price is at $3,000 and is expiring in 1 week. The premium is 10% (0.1 ETH) and is paid upfront after the auction. 
Scenario 1: The market price of ETH decreases to $2,000 at expiry (below the strike price & below the initial price)
1.The call option expires worthless and the user would have collected 0.1 ETH worth of premiums from selling the option
2.Net ETH Position: 1 ETH + 0.1 ETH = 1.1 ETH (+10%)
3.Net Cash Position: 1.1 ETH x $2,000 = $2,200
4.Net cash position if the user did not sell the call option: 1 ETH x $2,000 = $2,000
5.The user would have increased his/her net cash and ETH position by 10% by selling the covered call option.
Scenario 2: The market price of ETH increases to $2,750 (below the strike price & above initial price)
1.The call option expires worthless and the user would have collected 0.1 ETH worth of premiums from selling the option
2.Net ETH Position: 1 ETH + 0.1 ETH = 1.1 ETH (+10%)
3.Net Cash Position: 1.1 ETH x $2,750= $3,025
4.Net cash position if the user did not sell the call option: 1 ETH x $2,750 = $2,750
5.The user would have increased his/her net cash and ETH position by 10% by selling the covered call option.
Scenario 3: The market price of ETH increases to $3,500 (above the strike price, above the initial price)
1. During settlement, the call option is exercised, and the market maker has the right to buy from the option vault 1 ETH at the strike price of $3,000. The $3,000 collected from the buyer is then used to purchase ETH back from the market. But because ETH is now $3,500, only 0.8571 ETH can be purchased back with $3,000.
2. The user had collected 0.1 ETH worth of premiums from selling the option.
3. Post-Settlement ETH Position: 0.86 ETH + 0.1 ETH = 0.9571 ETH.
4. Post-Settlement Marked-to-Market (MTM) Cash Value: 0.9571 ETH x $3,500 = $3,350.
5. Cash Value if the user had not participated in the vault: 1 ETH x $3,500 = $3,500.
6. Thus overall, the user had lost 0.0429 ETH during this cycle, representing a MTM Cash Value loss of 0.0429 ETH x $3,500 = $150. This can also be calculated by taking the value in (5) - the value in (4) = $3,500 - $3,350 = $150.
Last modified 1mo ago