This dumpster fire of a year has taught me a lot. I started off as a degen and farmed ridiculous yield farm and governance tokens. I dabbled in over-leveraged wheels of imploding algorithmic stablecoins (I got out right before the crash, somehow), and dumped stupid money into a Tomb Fork.
Thankfully, I’ve evolved and am a slightly more sophisticated (hobbiest) trader. After the wave of CeFi failures and the loss of $2B from the ecosystem, I’ve come to the opinion that the only safe yield comes from derivatives-based strategies. Derivatives are tried and true system, and there will always be people lined up to trade contracts.
Ribbon’s DOVs and other structured products are simple by design, but that doesn’t mean you can’t use them as a part of a larger or more advanced trading strategy. In fact, they make it all simpler since half of the work is done by the vault. The possibilities and combinations are endless, but let’s explore a few.
STRATEGY #1 — T-ETH-C Bull Call Spread
A Bull Call Spread is a good strategy for traders to profit from a gradual rise of the underlying asset. It entails selling an out-of-the-money call, while simultaneously buying an in-the-money call. With this position, losses are limited to the net cost of the spread. Maximum profit equals the difference in strike prices, minus the net cost.
For example, let’s say you have 1 ETH to invest, and expect it to trade sideways before increasing in value over the next two months. The current price of ETH is $1275, and the weekly strike price of the T-ETH-C vault is $1350. Depositing ETH in Ribbon’s T-ETH-C vault takes care of the OTM call, leaving you to only need to open the ITM call with a strike price equal to or less than the current spot price. With a spot price of $1275 we’re going to buy a long call with a $1200 strike price for a $200 debit (the cost of the option).
ETH SPOT PRICE — $1275
T-ETH-C VAULT STRIKE PRICE — $1350
ITM CALL STRIKE PRICE — $1200
Two months pass, and on the last week the spot price of ETH jumps to $1500. For simplicity, let’s say that the vault options expired OTM every week, with the final week ITM. When the vault options expire OTM, we can expect a maximum yield of around 1%. In the case of the final week we have a drawdown of -5%.
T-ETH-C — $1000 deposit
7 weeks OTM @ 1% = +$70
1 week ITM @ -5% = -$50
Cost of purchased ITM call — -$200
ITM call gross profit — $300
You’re left with a net credit of $20 from the vault. You lost your ass a bit on the upside from the final week, but luckily you hedged by buying the ITM call! That earned you an additional $300, minus the cost of the option, making your total yield $120.
If the vault had expired OTM every week, you would have a vault yield of $80, however your ITM call will have expired worthless. You’d end up with a net loss of -$180.
PROS
- this strategy allows you to reduce the cost of just buying a single ITM option
CONS
- profits are limited
RISK
- net premium paid + loss in the case of the vault expiring ITM
STRATEGY #2 — T-WBTC-C Protective Collar
A collar is generally used for someone that is long on an asset, but wants to protect against downside risk. Traditionally, it involves holding a long position in the market, selling OTM calls on that position, and purchasing an OTM put. The premiums earned from the covered calls help to pay for the put, while the put offers downside protection.
Let’s say we have 1 BTC that’s trading at a spot price of $11,000. We think that the price is going to go down over the following weeks, and want to protect our downside in case we need to sell at the end of the month. We decide to set up a collar strategy. The T-WBTC-C vault abstracts away holding and selling calls for us, so we deposit our 1 BTC in the vault which has a current strike price of $12,000. We select an OTM put with a $10,000 strike price, for a total cost (debit) of $75.
BTC SPOT PRICE — $11,000
T-BTC-C VAULT STRIKE PRICE — $12,000
OTM PUT STRIKE PRICE — $10,000
A month goes by and on the final week, BTC is trading at $8,000. Let’s say that the vault options expired OTM every week. We expect a yield of around 1% for four weeks.
T-BTC-C — $10,000 deposit
4 weeks OTM @ 1% = +$400
Cost of purchased OTM Put — -$200
OTM Put gross profit — $2000
The yield from the vault is great, but you do in fact need to sell your BTC. Thankfully, your OTM put covers the drop in BTC spot price. Your OTM put’s strike was $10,000, and the price of BTC at expiry went down to $8,000, leaving you with a $2k net difference — $1800 after deducting the cost of the put. Add that with the vault yield, and you’re walking away with a $2200 total yield. Your BTC is at $8,000, so you’re slightly under where you were when you started, but much better off than you would be without the put!
PROS
- hedges against risk of downside loss on a long position
CONS
- limited upside potential
RISK
- net premium paid + loss in the case of the vault expiring ITM
STRATEGY #3 — R-EARN Long Strangle
This strategy works for anyone is interested in the principal-protected yield of R-EARN, while still taking advantage of extreme market movements. The R-EARN vault earns a base APY and uses the remaining funds to purchase weekly at-the-money knock-out barrier options. The epoch of the vault is one month, which includes 4 weekly option purchases. Knock out options are cheap and only the option premiums are at risk. However, the upside is limited in that if the asset price breaks a barrier, the options expire worthless.
Let’s say you have USDC to invest, and you like the principal protection of R-EARN, but don’t want to miss out on ETH price swings that would end up break both barriers. One way to hedge knock-out options would be to purchase OTM knock-in options. There are a few platforms that offer knock-in crypto options, but they are few and far between. Instead we can purchase a vanilla call and a vanilla put with strikes outside both legs of the barrier — the vault produces a bonus yield unless the price swings +/-8% in either direction.
For example, let’s say the current spot price of ETH is $1190. This means that for that week, if the spot price of ETH fell below $1100 or rose above $1250, the knock out options would expire worthless and the vault would only make the base APY of 4%. With this in mind, we make a $5,000 deposit in the vault.
For this week, we would buy an ETH call option at $1250, and a put at $1100. Since R-EARN runs a weekly strategy within the month long epoch, this needs to be repeated weekly, adjusting the strike prices for the current spot price of ETH.
ETH SPOT PRICE — $1190
R-EARN VAULT STRIKE PRICES — $1100 and $1250
ETH OTM CALL STRIKE PRICE — $1250
ETH OTM PUT STRIKE PRICE — $1100
You make your R-EARN deposit, and place your call and put options, which set you back $60 for the call and $10 for the put. You were prepared to let the R-EARN deposit ride out for a month, but during the first week the spot price of ETH suddenly rises to $2000. The knock-out options purchased by the R-EARN vault are breached and expire worthless, but you still get the base 4% APY, prorated to 1% for the 1 week of action.
R-EARN — $5000 deposit
1 week OTM @ 1% = +$50
Cost of purchased OTM call — -$40
OTM call profit — $750
Cost of purchased OTM put — -$30
OTM put profit — expires worthless
Deducting the cost of the options, we are left with a yield of $730.
PROS
- offers unlimited profit potential in both directions while still participating in base APY
CONS
- only profitable with massive price swings in the underlying asset
RISK
- limited to the net premiums paid
DOVs are likely to become an increasingly important tool for those looking to automate one or multiple legs of their trading strategy. The next time you’re looking to create a spread, try using DOVs to simplify your strategy and see if it fits into your trading style. I’ll end this by emphasizing that I’m but a simple and stupid man who has fun investing and is self taught. Please do your goddamn reading, and learn how this stuff works so you can safely invest your hard earned money. This post was written for a Ribbon community bounty.
