Our options
Now that you the basics of regular options mechanics, it's time to check our understanding of options.
As you read before, an option contract represents a right but not an obligation to the option buyer. On the other hand, the option seller makes a commitment to allow the buyer to exercise the option in case it wants to.
And we allow users to interact with such contract rules by allowing them to interact with Pods.
Pod is our primitive. It is how one issue, hold and transfer an option contract in the market.
How Pods work?
PodOptions represents the right of the buyer to exercise an option.
An option is issued when a seller decides to lock collateral and mint a Pod. After PodOptios are minted, they are sold at Uniswap for a premium, at market rate. The buyer should hold a Pod until expiry or prior, if it wants to exercise the contract. If the buyer chooses to exercise the option, it will have to provide L + underlying asset (in the case on a put option). When this happens, the buyer unlocks the collateral inside the contract and burn PodOptions.
Our put options (aka PodPut)
Consider a put option for ETH:DAI, strike price 100, premium 3 DAI, expiration date May 30.
A put option for ETH:DAI represents the right but not the obligation of the buyer to sell ETH at strike price at any moment until expiration.
The notation ETH:DAI represents that ETH is the underlying asset and DAI is the strike asset. Since this is a put option on ETH price, the collateral will be held in DAI.
The seller has to lock collateral in the contract, mint PodPut and sell them in Uniswap at market rate. The seller will receive the premium (3 DAI) and its collateral will be locked inside the contract until expiration (May 30). By locking collateral and agreeing to the contract terms (strike, expiry date, premium, American option) it is also agreeing to be exercised, if the buyer chooses.
In the case of exercise, the buyer will deliver PodPut + underlying asset back to the contract. The seller will receive ETH and those PodPuts will be burned.
Our call options (aka PodCall)
Consider a call option for ETH:DAI, strike price 250, premium 3 DAI, expiration date May 30.
A call option on ETH:DAI represents the right but not the obligation of the buyer to buy ETH at strike price at any moment until expiration.
The notation ETH:DAI represents that ETH is the underlying asset and DAI is the strike asset. Since this is a call option on ETH price, the collateral will be held in ETH.
The seller has to lock collateral (ETH) in the contract, mint PodCalls and sell them in Uniswap at market rate. The seller will receive the premium (3 DAI) and its collateral will be locked inside the contract until expiration (May 30). By locking collateral and agreeing to the contract terms (strike, expiry date, premium, American option) it is also agreeing to be exercised, if the buyer chooses.
In the case of exercise, the buyer will deliver PodCalls + DAI back to the contract. The seller will receive ETH and those PodCalls will be burned.
American options and physical settlement
Our options are set to be exercised at any moment until expiration and therefore, we are using American options format.
For cash settlements to work on a decentralized way, we’d need a price oracle to make sure the amount each party has to pay is correct and due. That would make us exposed to price oracles and liquidations. On the other hand, physical settlement assumes that all the collateral will be exercised, and that solution does not require a price oracle and liquidation system.
Specially if you keep in mind that in the case of a put option, it makes no sense to exercise an option that is out-of-the-money. For call options, thought, it represents a downside on its pricing.
A call option represents the right to buy the underlying asset at the strike price. If there is no price oracle, there is no way to know if the spot price actually got close to the strike price. Meaning that the price of a call option, when it’s a physical settlement with no price oracle, should not be less than the difference between the spot price with the strike price in order to avoid instant and pure arbitrage. We understand that this makes little sense for the usability of call options and we’ll improve this part of our contracts soon.
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