Maximizing your potential returns with minimal capital? ๐ฐ It's not magic, it's capital efficiency! ๐ฎ
๐ช๐ Weโll discuss 4 options strategies that can help you make more money with less capital:
Which of the 4 options selling strategies is the MOST capital efficient?
โ Panoptic (@Panoptic_xyz) April 6, 2023
What is capital efficiency?โ
In options trading, it's the ability to control a maximum amount of funds with minimal capital investment. It measures how effectively you use available capital to achieve your desired trading objectives.
Sounds complicated? Donโt worry, weโll ELI5 (๐ต๐๐)!
Imagine a conveyor belt of small bananas ๐. As the bananas ๐ pass through the magic box ๐ฆ, they turn into GIANT bananas ๐๐.
- Small banana ๐ = initial investment
- GIANT banana ๐๐ = funds you control
- ๐= Panoptic's collateral tracker
Let's look at the formula๐
That is, capital efficiency is the ratio of "notional value" to collateral.
- Collateral: Funds backing the position
- Notional Value: The value a position controls
(Both of these differ from "option value", which is the premia)
In Panoptic:
- Sellers get up to 5x leverage
- Buyers get up to 10x leverage
In other words:
- Selling a 1 ETH option requires 0.2 ETH in collateral
- Buying a 1 ETH option requires 0.1 ETH in collateral
So which strategy is most efficient? Let's find out!
Strategy #1 - Naked Callโ
Naked calls ๐๐ are pretty efficient...Naked Call ๐๐ = sell 1 call:
2/14 ๐ฐ Selling call options gives you the ability to earn premium income.
โ Panoptic (@Panoptic_xyz) March 31, 2023
But if you sell a naked (unhedged) call, you're taking on unlimited risk since you're obligated to sell the underlying asset at a preferential price if the buyer exercises the option. pic.twitter.com/FrNnDLzcMh
- Collateral: 0.2 ETH
- Notional Value: 1 ETH
- โ Capital Efficiency: 5x ๐
That's very capital efficient ๐, but also risky ๐ณ: naked calls have infinite risk ๐
Let's compare with covered calls!
Strategy #2 - Covered Callโ
Covered Call ๐๐ป๐ = sell 1 call + hold asset:
4/14 The payoff of selling a covered call is the same as a naked put.
โ Panoptic (@Panoptic_xyz) March 31, 2023
(Bonus point: covered call = naked put = Uniswap LP ๐คฏ) pic.twitter.com/1d7xAO8pVr
- Collateral: 1 ETH
- Notional Value: 1 ETH
- โ Capital Efficiency: 1x ๐
Covered calls require you to hold the full amount of the underlying asset, so it won't be as efficient.
Let's try the "Poor Man's Covered Call"!
Strategy #3 - Poor Manโs Covered Callโ
Poor Man's Covered Call (PMCC) โ๏ธ๐ง is a synthetic covered call. It's like a covered call, but you don't need to hold the underlying asset. PMCC โ๏ธ๐ง = sell 1 call + buy 1 call:
17/25 A variation of ๐ ๐ง is the "diagonal spread" โ๏ธ๐ง
โ Panoptic (@Panoptic_xyz) February 22, 2023
Also called a "Poor Man's Covered call" โ useful when you expect minor price movement.
Limited upside ๐
Limited downside ๐
Bullish โฌ๏ธ
Long long-term call + short short-term call (different strikes) pic.twitter.com/zoj4CKVJUK
- Collateral: 0.2 ETH + ~0.1 ETH
- Notional Value: 2 ETH
- โ Capital Efficiency: ~6.66x ๐
(Note: the collateral for buying the call is slightly larger than 0.1 ETH. This is because there is an โin-the-money amountโ that is equal to the max loss the long position can suffer in terms of intrinsic value. Hence, the capital efficiency will be slightly less than 6.66x.)
Strategy #4 - Short Straddleโ
Selling straddles is a bet against volatility. Can straddles beat the previous 6.66x efficiency? Straddle ๐คธ๐ฝโโ๏ธ = sell 1 call + sell 1 put:
- Collateral: 0.2 ETH + 0 ETH
- Notional Value: 2 ETH
- โ Capital Efficiency: 10x ๐คช
Wow, 10x efficiency is the most! Why's that? Straddles are made up of 2 legs: 1 call & 1 put. Only one leg can be โtestedโ at any given time, i.e. if the put is ITM then the call is OTM, and vice versa. Hence, collateral req. for selling straddles is relaxed to just the req. of one leg (whichever is larger). ๐คฏ
Cool fact about capital efficiency which will be implemented in @Panoptic_xyz
โ Guillaume Lambert | lambert.eth | ๐ฆ๐ (@guil_lambert) November 17, 2022
Collateral for selling options on $SPY:
-25โ put=$5800
-25โ call=$5900
-Strangle=25โ put + call =$5960
Why not 2x larger? Only one side can be ITM at a time, so no extra risk for adding 2nd leg!
Summaryโ
In order of capital efficiency:
- Straddle
- Poor Man's Covered Call
- Naked Call
- Covered Call
Caveats:
- Collateral requirements above assume normal market conditions ("target pool utilization")
- See more here
For more examples of capital efficient strategies and Options Trading 101 basics, visit here.
Question:
- How well do DeFi straddles perform? (Future #ResearchBites ๐)
Disclaimer:
- ๐ข None of this should be taken as financial advice.