Futures and Options Markets

 

Instructor: Andreas Park

 

• Perpetual futures are a main finance innovation in crypto
• one of the biggest markets by notional volume
• unique challenges for decentralized markets: Lyra
• options and AMM spot highly related: Panoptic

Content

Some Data

Perpetual Futures:
Centralized (Derebit/BitMEX/Binance) and Decentralized (Hyperliquid)

Introduction

• Focus: how crypto futures and perpetual contracts work
• Compare to traditional futures markets
• Explain funding, margin, and leverage mechanics

Forwards \(\to\) Futures: Definitions

• Futures returns scale roughly linearly with leverage until margin exhaustion.
• Both long and short must post initial margin.

Why trade with futures? Profit and Leverage Basics

• Purpose: collateral protects against default; losses paid daily via variation margin.
• Initial margin: minimum deposit to open position (1–10 % typical).
• Maintenance margin: lower threshold triggering liquidation when breached.
• Notional tiers: larger positions require higher margin.
• Mark price:
  • Estimated “fair” value from a basket of spot exchanges.
  • Used for unrealized P&L and liquidation to avoid false triggers.
• Mark-to-market: exchange continuously credits winners and debits losers.
• Differences vs traditional futures:
  • Crypto markets trade 24/7, with exchanges combining broker + clearinghouse functions.
  • No external CCP; default risk absorbed by insurance fund.

Margin Basics for Futures

• Introduced by BitMEX (2016) to enable 24/7 leveraged trading without expiry.
• No expiry: position stays open as long as margin is sufficient.
• Expiry convergence (standard future): price aligns with spot as maturity T approaches (arbitrage).
• Spot anchoring (perp): funding payments every few hours pull perp price toward index continuously.
• Benefit: no rollovers, continuous exposure.

What is a Perpetual Future (="perp")?

• Index price
  • Average of spot prices across major exchanges.
  • Reference value for “fair” pricing.
• Mark price
  • Index plus smoothed short-term premium adjustment.
  • Used for liquidation and unrealized P&L to avoid volatility spikes.
• Premium: Difference between perp and index prices.
  • Positive premium (Perp > Index): longs pay shorts.
  • Negative premium (Perp < Index): shorts pay longs.
• Basis (traditional usage): the difference between the futures price and the spot (index) price. 

  • Positive basis (futures > spot) → market in contango.

  • Negative basis (futures < spot) → market in backwardation.

• Premium in perpetuals is analogous to the ‘basis’ in standard futures, except that it’s continuously settled through funding rather than expiring and converging at maturity.

Key Terms: Index, Mark, and Premium/Basis 

Numerical Example: Funding and Margin Lifecycle

• Funding is exchange-mediated, not direct peer-to-peer.
• Exchange debits one side’s accounts and credits the other.
• Sign convention:
  • Perp > Index → Funding > 0 → longs pay shorts
  • Perp < Index → Funding < 0 → shorts pay longs
• Longs and shorts always match in total notional (though trader counts differ).
• Funding compensates for directional pressure—if many want to go long, they pay to do so.
• Example: 10 small longs vs 1 short of equal total notional.
  • Each long pays its fraction (e.g., $0.10 each), the short receives total funding ($1).

Who Finances Whom? (Funding Flows)

Isolated Margin

• Margin allocated per position.
• Liquidation limited to that position’s equity.
• Preferred for high leverage and short-term trades.

Cross Margin

• All positions share one margin pool.
• Profits on one leg offset losses elsewhere.
• Preferred by hedgers and market-makers.

• Exchanges apply “haircuts” or higher initial margin on volatile collateral.

Background: Margin Modes and Collateral Types

Scenario:
Trader A long 1 BTC (cross) with USDC collateral.
Trader B long 1 BTC (isolated) with ETH collateral.
Index = $10 000, Initial = 10 %.

Cross vs. Isolated Margining: An example

Decentralized Futures: Hyperliquid

• Futures and perps both use margin and daily settlement; perps replace expiry with funding.
• Mark price and funding keep perp near the index.
• Leverage magnifies both profit and loss.
• Exchange (centralized or on-chain) acts as clearing counterparty.
• Risk comes from volatility, margin adequacy, and funding flips.

Summary of Perp Functions and Markets

Decentralized Options: Aevo/Lyra

• Spot (cash) markets: direct exchange of assets.
• Options: contracts for future trades — require assurance that the writer can deliver.
• In pseudonymous systems, collateral replaces credit.
• On-chain models pool collateral and price options algorithmically (AMMs).

From Cash Markets to On-Chain Options

• Liquidity providers deposit collateral into Market Maker Vaults (MMVs).
• MMVs back multiple strikes and maturities for one asset.
• AMM layer: dynamically quotes option premiums and adjusts implied volatility.
• Delta pool: hedges exposure by trading the underlying on external markets.
• LPs earn option premiums minus hedging costs; positions remain fully collateralized.
• Withdrawals allowed subject to vault risk limits and cooldown.

Aevo/Lyra Overview

• Traditional OCC (Options Clearing Corporation):
  • Acts as central counterparty; guarantees exercise and assignment.
  • Requires margin reflecting net portfolio risk (SPAN methodology).
  • Allows offsets across positions (e.g., spreads, covered calls).
• Aevo:
  • Smart contract replaces OCC; collateral locked on-chain.
  • 100 % collateralization — each option’s full exposure is backed in the vault.
  • Automated hedging substitutes for clearing-house margin monitoring.
• Result: Aevo provides certainty of settlement but with higher capital lock-up.

Margin and Collateralization (OCC Analogy)

Assume:

• LP deposits 10 000 USDC in ETH-call vault.
• AMM sells 10 call options, strike = 2 000 USDC, premium = 100 USDC each.
• Premiums received: 1 000 USDC → vault balance 11 000 USDC.

LP withdraws collateral proportionally after expiry.

Numerical Illustration

GreekSymbolMeaningInterpretation

• Aevo’s AMM monitors Delta and Vega:
  • Delta hedged via the Delta Pool.
  • Vega managed by adjusting implied volatility in quotes.

Reminder: The "Greeks" in Option Pricing

Collateral and Margin Risk: Aevo vs OCC

• Aevo replicates clearinghouse collateralization through smart contracts.
• AMM + Delta Pool maintain solvency and automate hedging.
• LPs earn option premiums, carry Vega risk, but face minimal counterparty exposure.
• Main trade-off: safety and transparency vs. capital efficiency.

Summary

Decentralized Options: Panoptic

short put = short call + asset = covered call

-long call = - long put - asset = covered put

Price RegionToken CompositionOption AnalogueExposure Type

• Adding liquidity gives short-volatility exposure (short gamma).
• Removing or shorting LP positions gives long-volatility exposure (long gamma).
• The exact option analogue depends on where the current price sits relative to the LP’s active range.

Directional Option Analogy for a Uniswap v3 LP

Panoptic's Overarching Idea

1. LP position payoff \(\Rightarrow\) short put option (locally)
2. Short LP position \(\Rightarrow\) long option (whether call or put depends on current price relative to range (last slide)
3. Fees Collected \(\Rightarrow\) options premium payment

\(\Rightarrow\) they become an options clearing house 

• Panoptic transforms Uniswap v3 liquidity into tradable, perpetual options.
• Every LP range ([P_a, P_b]) behaves like a short option position (short gamma).
• Panoptic builds a clearing layer allowing traders to:
  • Borrow LP positions → go long options
  • Provide LP positions → write (short) options

Panoptic Overview

• Liquidity Providers (LPs) deposit tokens into Panoptic vaults.
  • Vaults place funds into Uniswap v3 as price-range liquidity.
  • LPs earn both swap fees and option premiums.
• Traders open synthetic option positions:
  • Panoptic constructs the corresponding Uniswap LP position on their behalf.
  • Traders post collateral (e.g., USDC or ETH) to ensure solvency.

How it works

• When you add liquidity, you are short volatility:
  • You sell convexity and collect trading fees.
  • Locally equivalent to writing a short put.
• When you borrow or short LP positions, you buy convexity:
  • You pay a premium to gain the upside from volatility.
  • Equivalent to buying an option.

Mechanics

LPs in Panoptic earn two income streams:

\[ \text{Total Yield} = \text{Uniswap Swap Fees} + \text{Panoptic Option Premiums} - \text{Hedging Costs}. \]

• Swap Fees: regular Uniswap v3 fees from trades within the LP’s range.
• Option Premiums: payments from traders who go long convexity (buy options).
• Hedging Costs: implicit from rebalancing (impermanent loss, gas, etc.).

This dual-income model compensates LPs both as market-makers and as option writers.

Fee Structure

• LP position payoff: locally equivalent to a short put.
• Short LP position (borrowed): equivalent to a long option.
• Fees collected: represent the option premium — the income for bearing short-gamma risk.

Payoff Structure

• Panoptic formalizes the hidden option exposure of AMM liquidity.
• It allows explicit trading of volatility on-chain, without expiries.
• LPs earn more efficient compensation for risks they already take.
• Traders gain perpetual options backed by Uniswap liquidity — a DeFi-native volatility market.

Why it matters

Aevo vs Panoptic: Structural Comparison

Summary

• Aevo replicates the structure of traditional options markets with expiries and full collateralization.
• Panoptic abstracts the same risk using Uniswap’s constant-liquidity bands, enabling perpetual, path-dependent option payoffs.

Comparison Aevo - Panoptic

• Underlying (ETH) spot \(S_0 = 2{,}000\) USDC.
• Uniswap v3 LP range: \([P_a, P_b] = [1{,}800, 2{,}200]\) USDC/ETH.
• LP notional deposited: \(10{,}000\) USDC equivalent at \(S_0\).
• Expected Uniswap swap-fee APR (inside range): 8% (example).
• Panoptic option premium charged to go long convexity on this range: 3% of notional per 30 days (paid to LPs; example).

Panoptic numerical example (perpetual option built on Uniswap v3)

• You provide the range liquidity through Panoptic → short option exposure.
• Income streams (30 days):
  • Uniswap fees: \(10{,}000 \times 0.08 \times \frac{30}{365} \approx 65.75\) USDC
  • Panoptic premium from long-option traders: \(10{,}000 \times 0.03 = 300\) USDC
  • Gross income \( \approx 365.75\) USDC (ignores gas and slippage)

Spot paths at day 30 (illustrative, no fees outside range):

Case A — LP via Panoptic (short volatility)

• You post collateral and borrow the LP exposure (mirror of LP).
• Premium paid (upfront): (300) USDC for 30 days.

Payout intuition at day 30 (ignoring path costs):

• If \(S_{30}\) moves far from 2,000 (either direction), long option gains convexity.
• If \(S_{30}\) stays near 2,000, time-value decay (no realized vol) → premium cost dominates.

Numerical sketch (example, marking to range convexity):

Numbers illustrate the idea: the long option benefits when realized volatility is high; the LP (short option) benefits when price stays within the range and fee + premium exceed inventory losses.

Case B — Trader goes long Panoptic option for same range

• LP via Panoptic: earns Uniswap fees + Panoptic option premium; bears short-gamma risk inside \([P_a,P_b]\).
• Long Panoptic option: pays premium; gains convexity if \(S_t\) moves enough.
• No expiries: positions are perpetual; economics come from range choice, realized vs implied vol, and fee flows.

What to highlight on the slide