Margin

How margin trading is implemented in Panoptic

Margin Requirements

In traditional finance, some types of accounts such as IRA or Level 1 trading accounts require all options to be fully collateralized. Specifically, users in IRA accounts can only sell cash-secured puts or covered calls, which means they must deposit the notional value of the underlying position in cash (for cash-secured puts) or own the underlying shares (for covered calls).

Undercollateralization is handled by reducing the buying power requirement of an asset. A Level 4 trading account in a TradFi brokerage firm allows users to sell naked puts and naked calls by posting 5x less collateral than users in a Level 1 account. For portfolio margin accounts, the collateral requirements could be even smaller, requiring about 10-15x less collateral than a Level 1 account.

Panoptic makes use of built-in leverage similar to Level 4 trading accounts to enable the minting of undercollateralized options. The collateralization requirements follows the guidelines outlined by CBOE and FINRA, which - for selling put options - can be summarized as follows:

$$\mathtt{MaximumOf\left[notionalValue \cdot 20\%,\ notionalValue\cdot\left(1-80\%\frac{Price}{strike} \right)\right]}$$

It helps to visualize the collateral requirement for a short put at strike K compared to the in-the-money amount and the liquidation bonus (more details in the liquidation page) in a graph:

In the figure above, two key elements are illustrated:

1. In-the-money (ITM) amount: This represents the intrinsic value of the option. Essentially, it is the loss incurred by the seller in the event the buyer exercises the option. In this situation, the seller is obligated to sell the underlying asset at a preferential price, which results in a loss for them.
2. Required collateral: This is the amount of collateral that the seller must post to cover any potential losses that may arise from selling the option.

It is important to note that the required collateral (depicted by the blue line) is consistently higher than the ITM amount (represented by the red line) in the figure. This design feature ensures that there is a sufficient "buffer" of collateral to protect the protocol against sudden losses that could stem from extreme price movements. This additional layer of protection helps maintain the overall stability and security of the system.