YFI Proposal - Adding optionality to stablecoin yields
Summary:
We propose to create a vault that uses stablecoin yield and adds optionality. The vault will use YFI 3crv vault yield to purchase ETH call options. Based on recent past performance, this vault gives an APY of 0.24% minimum with an optionality component yielding up to 160%.
Abstract:
Declining dollar index values, and explosion in the value of ETH with strong upside possibilities still to be realised, gives a unique opportunity to DeFi investors to stake their stablecoins at market rates with exposure to future gains in ETH prices.
The pool takes the interest earned from the 3pool, purchases 28 day ETH call options and reinvests the profit from those call options back into the pool.
Motivation:
YFI vaults already enable investors to gain yields that are above traditional market rates. With the new upcoming Deriswap platform, investors in Yearn can also get exposure to futures and options.
YFI’s 3crv pool would be a good fit with it’s meta-stable approach, giving DAI, USDT, and USDC owners high returns.
We propose that we invest part of the yields earned from the 3 pool into buying call options on Deriswap.
Which calls to buy?
We propose buying ETH calls that are 3-5% Out of the Money (OTM) with a 28 day expiration. There are several considerations in making this decision. We’re trying to optimize for cost and return, and in a sustained bull market, we believe these options will have the best risk/reward profile for this particular strategy while maintaining front month liquidity characteristics of traditional options markets. The strategy may be changed depending on market conditions.
Optimizing for Cost
Part of optimizing for cost, is trying to find “cheap” relative costs. This is done through comparing implied volatilities of a particular month’s options. In our proposal, we’re going to be focusing on calls expiring in 28 days. In general, in a bullish market, we will find that OTM calls will have a lower implied volatility than at-the-money or in-the-money calls. This is due to the natural volatility skew characteristics of vanilla options, dictated by supply and demand. People tend to sell calls and buy puts, especially if they’re already long the underlying. Focusing on slightly OTM calls will help us optimize our strategy by taking advantage of this skew. Advanced volatility strategies, month to month skews, convexity, contango and other nuances of volatility and pricing will fall outside this proposal, but can be used at a later date, or brought in as situations arise.
Optimizing for Return
When optimizing for return, the probability of your option expiring in-the-money, or delta, is something we want to be taken into account. As a definition, the higher the delta of your calls, the higher the probability of your option being in-the-money. In practice, along with that higher delta comes higher upfront cost of your calls. The calls we are buying are cheaper on an absolute basis due to them being slightly out of the money compared to ATM or ITM calls, and on a relative basis due to the implied volatility skew of options in general. With a slightly out of the money call, we are taking advantage of the lower implied volatility compared with at or in the money calls, so we can get more “bang for your buck” if the calls end up in the money.
| Date (28 days options expiry) | Principal1 | Yearn weekly ROI (28 days prior) | 28 days options ROI at expiry2 3 | Yearn APY (before call options) | APY with call options |
|---|---|---|---|---|---|
| 12/27/2020 | $1,000,000 | 0.31% | -24.75% | 16.20% | 0.03%% |
| 12/20/2020 | $1,000,000 | 0.31% | -3.59% | 16.25% | 2.78% |
| 12/13/2020 | $1,000,000 | 0.32% | 38.13% | 16.80% | 8.48% |
| 12/06/2020 | $1,000,000 | 0.20% | 192.61% | 10.28% | 17.90% |
| 11/29/2020 | $1,000,000 | 0.30% | 219.52% | 15.77% | 30.85% |
| 11/22/2020 | $1,000,000 | 0.38% | 149.86% | 19.66% | 27.50% |
| 1. For simplicity, the pool is assumed to be at constant $1 MM, without withdrawals and reinvested yields | |||||
| * returns assume 80% of yields from the 3pool are used to purchase call options | |||||
| * ETH call options bought at 3% OTM, premium cost assumed at 8.64% of spot prices |
Table: APY comparison for with and without options exposure
Implied Volatility chart for the last 3 months. We’ve assumed IV of 90%.
Deposits and Withdrawals:
If an investor puts $100k into a current $900k pool, using the returns for December, that $100k would grow to $100,240 after one week. That $240 would go to buying options which would expire in 28 days. At first glance, you are 10% of the pool and you should be able to withdraw 10% of the money in the pool. To negate someone “apeing” into a profitable pool, we lock your money for one day from deposit before you can withdraw. Your percentage of the pool from which you withdraw is calculated after your deposit has been made.
Potential users:
- Investors that are looking to protect themselves from decline in real world dollar marked assets but have limited exposure to ETH.
- Investors who have short positions on ETH but are looking to hedge.
- Investors who are looking for optionality on their stablecoin yields
POLL: Please comment and discuss 
- Adding a layer of optionality to stablecoin yields
- Doing nothing with yields