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What's the Most Capital Efficient Options Selling Strategy?

· 3 min read
Brandon Ly

Maximizing your potential returns with minimal capital? 💰 It's not magic, it's capital efficiency! 🔮

💪📈 We’ll discuss 4 options strategies that can help you make more money with less capital:

What is capital efficiency?​

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? Don’t worry, we’ll ELI5 (🐵👑👇)!

Imagine a conveyor belt of small bananas 🍌. As the bananas 🍌 pass through the magic box 📦, they turn into GIANT bananas 💉🍌.

img-1

  • Small banana 🍌 = initial investment
  • GIANT banana 💉🍌 = funds you control
  • 💉= Panoptic's collateral tracker

Let's look at the formula👇

Capital Efficiency=(💉🍌)🍌\text{Capital Efficiency} = \frac{(💉🍌)}{🍌}

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 Call​

Naked calls 🙈📞 are pretty efficient...Naked Call 🙈📞 = sell 1 call:

  • Collateral: 0.2 ETH
  • Notional Value: 1 ETH
  • → Capital Efficiency: 5x 😁

That's very capital efficient 😁, but also risky 😳: naked calls have infinite risk 💀

Let's compare with covered calls!

Strategy #2 - Covered Call​

Covered Call 🛌🏻📞 = sell 1 call + hold asset:

  • Collateral: 1 ETH
  • Notional Value: 1 ETH
  • → Capital Efficiency: 1x 😔

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 Man’s Covered Call​

Poor Man's Covered Call (PMCC) ↗️🧈 is a synthetic covered call. It's like a covered call, but you don't need to hold the underlying asset. PMCC ↗️🧈 = sell 1 call + buy 1 call:

  • Collateral: 0.2 ETH + ~0.1 ETH
  • Notional Value: 2 ETH
  • → Capital Efficiency: ~6.66x 😍

(Note: the collateral for buying the call is slightly larger than 0.1 ETH. This is because there is an “in-the-money amount” 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 Straddle​

Selling straddles is a bet against volatility. Can straddles beat the previous 6.66x efficiency? Straddle 🤸🏽‍♂️ = sell 1 call + sell 1 put:

img-2

  • Collateral: 0.2 ETH + 0 ETH
  • Notional Value: 2 ETH
  • → Capital Efficiency: 10x 🤪

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 “tested” 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). 🤯

Summary​

In order of capital efficiency:

  1. Straddle
  2. Poor Man's Covered Call
  3. Naked Call
  4. 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 😉)

Disclaimer:

  • 📢 None of this should be taken as financial advice.