June 2, 2022

IRO Strategies: Synthetic Long/Short Rates

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What are Synthetic Longs/Shorts?
A synthetic long/short is a strategy for options trading designed to mimic a long/short position. Traders create a synthetic long by purchasing at-the-money (ATM) calls and then selling an equivalent number of ATM puts with the same expiration date.
Synthetic longs and shorts come with an unlimited risk; however, they also offer an unlimited potential profit. A synthetic long/short position is a more cost-effective way to trade without tying up all the investment capital required to have an equivalent amount of exposure to the underlying. It can be created with very little capital because the cost of the call option is mainly offset by the money received for selling the put options.
A “Long” example: When you go on GMX and “long” ETH 2x, you expose yourself to twice ETHs price movement -So for every penny ETH moves, your position moves two making money on the upside.
The same goes for a “Short,” except you are making money on the downside.
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Great! Now that you are familiar with Synthetic longs and shorts, let’s go over two graphs showing both the synthetic long and the synthetic short payoffs.
This graph is your synthetic long position PnL. Depending on your position and strike price (X), you can see that the gains get exponentially more profitable once the strike is reached.
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-The Greenline reveals the payoff from the long call option position, with the strike being your max loss since the price of the call is offset by your sold puts
-The Redline illustrates your short put position, creating a position resembling a long.
The inverse relationship will be true for a Synthetic Short. By writing call options and purchasing put options with the same strike price, you will be able to recreate a position that resembles a short, with a linear payoff.
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->Greenline = Long put payoff (Gain)
->Redline = Short call payoff (Loss)
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Synthetic Interest Rate Options for Curve Rates!
Synthetic Long/Short Rates are just a lofty way of saying that you can bet on a Curve pool “APY Rate,” which fluctuates depending on a few factors.
Including:
  • The $CRV price
  • Delegated emissions through voting
  • The trading activity
  • And the pool liquidity
Longing/shorting these rates give users more exposure to these factors by using a mix of leverage and options.
A “Long” example: When you go on GMX and “long” ETH 2x, you expose yourself to twice ETHs price movement -So for every penny ETH moves, your position moves two.
How can we do this with IROs, you ask?
Simple, like mentioned in our first section of this article, say you are bullish on a certain pools rate and want to long it. First, you write an equivalent amount of ATM Puts to the notional value of the number of calls you wish to buy. In this case, we will write ~100k$ worth. (With 500x leverage, it should only take you~200$to do so.) Once the deposit period ends, you would then have to wait for your puts to sell to use that capital to buy ATM calls. For the sake of this article, we will assume all puts are sold on the first day. 100k$ worth of ATM Calls would cost you ~35.88$ in premiums considering 14 days left and 120% vol using the black 76 model. Since both options are ATM and have the same strikes, we can assume the premium received from writing puts will cover most if not all of the premium paid for buying the calls.
The same can apply to a short position; all you need is to invert the stated above, and rather than buying calls and selling puts, you would now instead sell calls and buy puts, creating a short position.
Example with numbers :
(Curve pool APY = 10%)
You write 100k$ worth of puts with a floating and strike rate of 10%
You buy 100k$ worth of calls with a floating and strike rate of 10%
The spreadsheet below displays the potential PnL at different strike rates. If the rate expires at 12%, you will receive 76.71$. An increase of (76.71/35.88)*100 = 213.79% with an initial deposit of 35.88$, with only a 2% rate increase!
Of course, this comes with its risks; if the floating rate of the pool decreases below your strike rate, your written put position will lose the same value for every percentage drop. (About 38.36$ for every percentage point or until your initial deposit gets wiped = 200$) *Put spreadsheet.
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About Dopex

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Dopex uses option pools to allow anyone to earn a yield passively. Offering value to both option sellers and buyers by ensuring fair and optimized option prices across all strike prices and expiries. This is thanks to our own innovative and state-of-the-art option pricing model that replicates volatility smiles.

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