UMA Call Options Now Live
Building Call Options on UMA (Part 2)
TL;DR : 1 million UMA call option tokens have been minted with a $35 strike price and April 30th, 2021 expiry. These call option tokens are all pooled with UMA tokens on SushiSwap and anybody is free to buy them if they want leveraged, limited downside exposure on UMA. UMA token holders can also mint and sell these call option tokens to earn income.
At the moment, there is no minting UI, but UMA will pay a bounty for the creation of one. Any DeFi project can design their own call option tokens on UMA’s infrastructure and take advantage of the many strategic uses. Expect more decentralized call option tokens to come in the near future.
In our last article, we explained what a call option is and how anyone can create a decentralized call option token using UMA’s infrastructure. These concepts have been used to design and launch a call option token with the UMA token as the underlying asset. This was created using the new Expiring Multi Party (EMP) contract recently deployed by UMA’s engineering team and takes advantage of some new features. There are many uses and benefits for other DeFi projects to consider using call option tokens in managing their governance token distribution and liquidity.
As a refresher, a call option gives the buyer the right, but not the obligation to buy an asset at a specified price (strike) and a specific time period (expiry). With UMA’s infrastructure, a call option token on the UMA token was created with with an expiry on April 30th, 2021 and a strike price of 35 USD. This token is named UMAc35–0421. These call option tokens are quoted in UMA and can be pooled with UMA tokens or other ERC-20 tokens on any AMM (Automated Market Maker).
This call option token was deployed using UMA’s new EMP contract and takes advantage of a useful new feature that will cut down on governance actions.
When deploying a new contract, developers can now refer to a financial product library to transform any approved price identifier. Given UMA is already an approved collateral type from UMIP56 and UMAUSD an approved price identifier from UMIP 57, no new UMIP or governance vote is needed to create this new token. One just needs to create a library contract that takes the price of UMA and determines what desired payout to return to the token contract.
For UMAc35–0421, the financial product library code can be viewed here and the deployed contract can be viewed here. This is a powerful feature that gives developers a lot of flexibility and speed in building tokens. In the case of options, developers can easily create a call option with any strike and with any approved collateral by simply designing their own library contract and with no need for a governance vote.
The design of this call option token implies a few things:
- Token sponsors do not need to manage their collateral ratios as it remains static for the life of the contract at 1 UMA token per 1 call option token.
- There will be no liquidation bots necessary and the ability to withdraw collateral or liquidate a position will effectively be disabled as the liveness period for these actions are set to extend beyond expiry. Users should not test these actions for their own safety. Of course, redeeming a token to retrieve locked collateral will still function as normal. As extra safety, the UMA team will run monitor bots to alert us of any accidents or abnormal activity.
- These call option tokens are “European Options” which mean they can only be exercised at expiry. There will only be one price request needed at expiry to settle the token. Also, with the new design of our optimistic oracle, settlements can happen just 2 hours after expiry if there are no disputes.
- The payout function in the Settlement Price implies “cash settlement” which means the token sponsor of the option will settle any profit due to the token holder, rather than take payment from the token holder for transfer of tokens.
Example
- Token sponsor deposits 1 UMA as collateral and mints 1 UMAc35–0421
- Token holder pays 0.05 UMA for this call option token. Now he has the right to buy 1 UMA for 35 USD at time of expiry.
On April 30th,2021
- If UMA/USD settles at 50 USD, the token holder receives 0.30 UMA [(50–35)/50] This is a profit of 0.25 UMA (0.30–0.05)
- For the token sponsor this economically represents him selling 1 UMA at 35 USD. He net gave away 0.30 UMA to the token holder, but with UMA trading at 50 USD his remaining position is worth 35 USD (0.70 * 50) which is the intended outcome. He also gains 0.05 UMA from the sale of the option. Looking at it another way, he effectively sold UMA at 37.50 USD (0.75 * 50).
- If UMA/USD settles at 34 USD, the token holder receives nothing. This is a loss of 0.05 UMA (0–0.05)
- The token sponsor keeps all of his collateral and earns the 0.05 UMA of premium.
Value of Call Option Token
Using a very simple Black-Scholes calculator on the web and some assumptions, a price for UMAc35–0421 can be calculated (see below). In general, the more volatile an asset, the more valuable an option is for that asset. Therefore, the number that drives the valuation of an option is the implied volatility. Given there is no existing options market for UMA one can use a similar strike and expiry on ETH options (on Deribit) as a reference for UMA’s implied volatility. This assumption is likely low for UMAc35–0421 given the UMA token is more volatile and less liquid than ETH; however, one can use this as a base to start the valuation. With the variables entered the call option token has a value of 0.055 UMA ($1.32 / $24). These call option tokens are tradable on SushiSwap now and the market can determine for themselves whether this price is fair or not.
Call Options Minted and Liquidity Mining
1,000,000 UMAc35–0421 call option tokens have been minted and pooled with UMA tokens on SushiSwap. Assuming the price is 0.055 UMA per option, the initial liquidity pool has $2.64MM (2*0.055*$24*1,000,000) with $24MM ($24*1,000,000) of UMA as collateral for the options. The initial tokens minted will not be included for the developer mining program. This liquidity provided will likely be removed a week prior to expiry to avoid the possibility of significant impermanent loss in the case of an option that decays worthless. This dynamic was explained in the previous article and this strategy chosen as a simple workaround. Other liquidity providers are encouraged to pull their liquidity as well to avoid this unfavorable scenario. This would imply that any remaining positions after this point in time may need to be held into expiry due to the lack of liquidity.
Uses for UMA Community
Leveraged Speculation
The simplest use for a long call position is for speculating on the appreciation of an asset with leverage and also limited downside. Anybody bullish UMA can obtain the right to be long 1 UMA at a price of 35 USD by paying only 5.5% of an UMA token. However, the flip side to that is the value of the option will depreciate or decay very quickly to zero if it does not trade above the strike price.
Income or Yield Enhancement
Existing UMA token holders can mint these call option tokens using their UMA token as collateral and then sell them to earn income or provide liquidity in them to farm more UMA. Especially for token holders who are willing to sell some of their UMA at 35 USD it would be a reasonable strategy. Assuming the call option trades at 0.055, if UMA rallies over 35 USD they would have sold their UMA at 36.925 USD (35 + 0.055*35). If UMA stays below 35 USD, the strategy would have earned the 5.5% premium in 1.5 months (~43.6% APY).
At the moment there is no friendly user interface for minting and managing a call option token. One can use alternative methods, such as Etherscan, to interact with the token contract and mint call option tokens there. The UMA team is offering a bounty for members of the community to create a UI for minting and redeeming call option tokens. The first functioning UI (as determined by the UMA community) will receive 200 UMA tokens (~$5k USD) and the UI that mints the most call option tokens from now till expiry will receive 300 UMA tokens (~$7.5k USD). As more call option tokens are created, the designer of this UI would be able to take advantage of dApp mining by simply expanding the UI to accommodate new contracts. Please contact the UMA team for more details if interested.
Uses for UMA and Other Defi Projects
Strategic Distribution of Tokens
Many DeFi projects have distributed their governance tokens either via air drops or through liquidity mining programs. The one downside is many recipients of the tokens may not be long term community members and instead are just looking to sell (or dump) the tokens which cause a depression in the token price. Distributing a mix of governance tokens and call options on these tokens could help prevent that immediate selling and also incentivize holders of the options to become a member of the community and help support the project. Simply forcing someone to hold a call option could lead them to learn more about the project as they watch the price of the token and wait.
Rewarding Community Members and Contributors
DeFi projects can award anybody contributing to the protocol call option tokens along with other compensation. This is similar to executives in the traditional corporate world being awarded stock options.
Utilize DeFi Project Treasuries
Currently, the majority of a DeFi project’s treasury consists of its own governance token. Call option tokens allow the project team to utilize these idle tokens now. It shows a commitment of tokens to the community through its expiry date and incentivizes the holder of these options to be long term supporters.
Conclusion
UMA’s infrastructure allows anybody to easily and quickly build a decentralized call option with any underlying asset. With the new EMP contract, as long as the collateral and price identifier is already approved by the UMA community, there is no governance vote needed to design and launch options with any desired strike and expiry. We believe call option tokens have many strategic uses for DeFi projects and we are happy to discuss and provide assistance to any teams interested in exploring this. This first implementation of option tokens has room for improvement, but it acts as a viable first test case for the DeFi community to learn about them and to see how it is received. We will continue to explore ideas to make option tokens more capital efficient and simpler for liquidity providers. Feedback is very much appreciated and any ideas on solving some of the issues and inefficiencies are welcome.
Resources
Token Address
Contract Address
Financial Product Library Deployed Contract
Financial Product Library Code
SushiSwap Pool
Trade on SushiSwap
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