A Guide to DeFi Options and Perpetuals

Detailed Instructions

A DeFi options contract is defined by several key parameters that are encoded on-chain. The most critical is the strike price, which is the predetermined price at which the underlying asset can be bought (for a call) or sold (for a put). The expiration date is the timestamp after which the contract becomes invalid. The underlying asset is the cryptocurrency the option is based on, such as ETH or WBTC. Finally, the option premium is the price paid by the buyer to the seller for the rights granted by the contract.

• Sub-step 1: Identify the Asset: Determine which blockchain asset (e.g., Wrapped Ethereum 0xC02aaA39b223FE8D0A0e5C4F27eAD9083C756Cc2) the option references.
• Sub-step 2: Set the Terms: Define the strike price in USD (e.g., $2,000) and the expiration in Unix time (e.g., 1719878400 for July 2, 2024).
• Sub-step 3: Calculate Premium: The premium is determined by market forces and pricing models like the Black-Scholes formula, often influenced by implied volatility.

Tip: On platforms like Lyra or Hegic, these parameters are immutable once the contract is minted, ensuring trustless execution.

Detailed Instructions

DeFi options are typically minted as ERC-721 tokens, representing ownership of the contract. Pricing is not done by a central entity but through automated market makers (AMMs) or peer-to-pool models. Sellers (writers) deposit collateral into a liquidity pool, and buyers pay a premium to mint a new option token from that pool. The premium is calculated using an on-chain pricing model that factors in the distance of the strike from the current price, time to expiry, and the volatility surface.

• Sub-step 1: Seller Provides Collateral: A writer locks 1 ETH in a pool to sell a call option with a $2,200 strike.
• Sub-step 2: Buyer Pays Premium: A buyer interacts with the pool's smart contract, paying 0.1 ETH as premium. The contract mints an NFT to the buyer's address.
• Sub-step 3: Minting Transaction: The mint function call might look like this:

codeCopy
optionsProtocol.mintOption(
  address(WETH), // underlying asset
  2200000000000000000000, // strike: 2200 * 10^18
  expirationTimestamp,
  true // isCall
);

Tip: The minted NFT is fully tradable on secondary markets like OpenSea before expiry, adding a layer of liquidity.

Detailed Instructions

Before the contract expires, holders have several choices. They can sell the option NFT on a secondary market to realize a profit or loss based on the new market premium. They might also use options for hedging an existing portfolio; for example, buying a put option to protect against a downside move in a held asset. Some protocols allow for early exercise, though this is less common in DeFi due to capital efficiency. Most activity revolves around trading the derivative token itself.

• Sub-step 1: Monitor Value: Track the option's mark-to-market value, which changes with the underlying asset's price and volatility.
• Sub-step 2: Execute a Trade: To sell your option NFT, you would list it on a marketplace with a command like approve() followed by createListing().
• Sub-step 3: Hedge a Portfolio: If holding 10 ETH, buy 10 put option NFTs with a strike near the current price to limit downside risk.

Tip: Use portfolio trackers like DeBank or Zapper to monitor your options positions alongside your other DeFi assets in one dashboard.

Detailed Instructions

At the precise expiration timestamp, the option contract settles automatically via its smart contract. For a call option, if the oracle-reported price (e.g., from Chainlink at 0x5f4eC3Df9cbd43714FE2740f5E3616155c5b8419) is above the strike price, it is in-the-money (ITM). The settlement is cash-settled in stablecoins or the underlying asset, meaning no physical delivery occurs. The smart contract calculates the profit as (Oracle Price - Strike Price) * Contract Size and transfers it from the pool's collateral to the option holder. Out-of-the-money options expire worthless, and the seller's collateral is unlocked.

• Sub-step 1: Price Oracle Query: The contract calls latestAnswer() on the designated Chainlink price feed at expiry.
• Sub-step 2: Profit Calculation: For a 1 ETH call with a $2,000 strike, if ETH is $2,500, profit is (2500 - 2000) * 1 = 500 USD worth of stablecoins.
• Sub-step 3: Automatic Payout: The holder calls a settle() function, and the contract verifies expiry and price before transferring funds.

Tip: Always be aware of the exact expiration block and the oracle source, as these are immutable and critical for a successful settlement.

The Funding Rate Engine

Perpetual contracts, or perps, do not have an expiry date. To keep their price tethered to the underlying asset's spot price, they use a funding rate mechanism. This is a periodic payment exchanged between long and short positions. If the perpetual contract trades at a premium to the index price, longs pay shorts. If it trades at a discount, shorts pay longs. The rate is calculated and applied typically every 8 hours.

• Check the Index Price: The contract references an aggregate price from major spot exchanges (e.g., a time-weighted average price from Binance, Coinbase, and Kraken).
• Calculate the Premium: Determine the difference between the mark price (the contract's fair price) and the index price.
• Apply the Rate: The funding rate is often capped (e.g., ±0.05%) and is applied proportionally to a trader's position size.

Tip: A positive funding rate indicates a bullish sentiment (longs pay shorts), while a negative rate indicates bearish sentiment (shorts pay longs).

Initiating a Trade with Margin

To open a position, you first deposit collateral into a smart contract vault. Common collateral assets include ETH, USDC, or wBTC. You then specify your desired leverage (e.g., 5x) and direction (long or short). The platform will calculate your initial margin and maintenance margin requirements.

• Deposit Collateral: Send 1,000 USDC to the protocol's vault contract (e.g., 0x1234...abcd).
• Set Leverage and Side: On the interface, select 'Long ETH/USD' with 5x leverage. Your position size becomes 5,000 USDC worth of ETH.
• Verify Liquidation Price: The system calculates the price at which your position will be liquidated if the margin falls below the maintenance threshold. For a 5x long, this might be ~15% below your entry.

Tip: Higher leverage increases potential profits but drastically raises liquidation risk. Always monitor your margin ratio.

Avoiding the Liquidation Engine

Your position's health is measured by its margin ratio: (Collateral Value / Position Size). If the market moves against you and your margin falls below the maintenance margin (e.g., 2.5%), your position becomes eligible for liquidation. A liquidation fee (e.g., 0.5%) is charged, and liquidators are incentivized to close your position at the bankruptcy price.

• Monitor Key Levels: Use the platform's dashboard to track your liquidation price and current P&L.
• Add Margin: To avoid liquidation, you can deposit more collateral by calling depositMargin(positionId, 200 USDC).
• Partial Close: Reduce your exposure by closing a portion of the position to improve your margin health.

Tip: Use stop-loss orders or set up price alerts external to the protocol, as on-chain liquidations can be swift during high volatility.

Finalizing the Trade

Closing a perpetual position is an explicit action that settles the profit or loss in the collateral currency. You can close at the current market price or set a limit order. Upon closing, the realized P&L is added to or subtracted from your collateral balance. Remember, funding payments are settled up until the moment of closure.

• Market Close: Execute a closePosition(positionId) transaction. The protocol calculates your final P&L based on the entry and exit prices.
• Settle Funding: Any accrued but unpaid funding is settled simultaneously. If you were long during a period of positive funding, this amount is deducted.
• Withdraw Collateral: After closing, your updated collateral (initial margin +/- P&L) is available for withdrawal via withdraw(asset, amount).

Tip: Always account for trading fees (e.g., 0.05% taker fee) and funding payments when calculating your net profit, as they significantly impact returns.