Under The Hood, How Does OptionBlitz Work?

INTRODUCTION

The OptionBlitz platform offers derivative products to the market. These are priced with industry standard techniques, which are sometimes simplified for the testing phase. At the final phase, i.e., before moving to mainnet, pricing will become more comprehensive.

This part is split into three logical parts:

1 — Discussion of pricing and margin structure.

2 — Risk management framework includes:

• Risk modelling and measuring
• Risk Management with limits and Risk Capital
• Link of Risk Capital to Liquidity provided by Liquidity Providers

3 — Revenue and profitability estimations

Overall, the approach is this. First, we define products, understand their price and risk performance with respect to price and volatility of the underlying. Second, the risk is equalised to the collateral, which is used to manage capital consumption. For our estimations we parameterize the relationship between product risk and its notional. Third, total collateral level is used to constrain capital consumptions and, therefore, we can estimate the respective notional to be traded. From that we calculate profitability due to profit margins and fees per unit of product and investment.

PRICING AND MARGINS

All products offered to clients are divided into two major classes:

• Bet products, where loss is known at the moment of sales (trade) and it is limited upfront. These are binary options: simple bet, one touch, no touch, double touch and double no touch;
• Another class are products with potentially unlimited losses for OptionBlitz. These are European/American options and turbos.

To clearly describe their profit/loss structure let’s define PnL contributions as following:

Risk forces us to keep a capital buffer, which protects Optionblitz from the default. This generates cost due to the lost investment opportunity. To compensate for that Optionblitz charges fees and profit margins. Margin must exceed price of risk to maintain overall PnL positive over the long run.

The resulting revenue will be divided among:

• Liquidity Providers as part of the fee for their liquidity contributions
• shareholders, as part of reward for their initial investments
• development efforts Refill capital levels during the period of great losses taken by OptionBlitz

VOLATILITY

Price and risk of the product depend on the volatility. OptionBlitz calculates volatility for each asset class off-chain from an oracle using 5-min interval data. We then apply an Exponentially Moving Average (EMA) algorithm and then record this value to the blockchain every hour. Volatility at other time horizons is scaled with simple root-square rule.

RISK MANAGEMENT AND RISK CAPITAL

Risks for these two product groups are calculated differently:

• Digital options/Binaries
• American options and turbos

In the first group risk is equal to the potential payment. In the second group, risk is equal to the change of value due to the worst-case-scenario estimated at the moment of sale.

COLLATERAL AS CAPITAL MANAGEMENT TOOL

Every sold contract contributes to PnL, but also adds risk to the book of Optionblitz, which requires strict measurement, management and control.

The risk is set equal to collateral locked with the contract. Contract decides what to do with collateral, when it triggers certain conditions predefined at the moment of trade. This guarantees fulfilment of the deal and provides control over consumption of the capital. When capital is completely consumed, Optionblitz stops selling products. Platform will resume trading when some of the collateral recovers and the capital is free again. System makes sure this condition is always satisfied:

INSURANCE FUND

Binaries and Americans expire at maturity; therefore, collateral management is applicable. In contrast, turbos are perpetual products and, therefore, the collateral system will not work here.

Instead, Optionblitz is building up a separate Insurance Fund which buffers all ongoing losses. Turbos profits refill IFund levels. IFund level is defined such that it is able to absorb a few days’ losses. All excess is defined as profit and distributed to investors. Overall risk is controlled via current risk exposures within the book:

CONCENTRATION RISK AND DIVERSIFICATION

Optionblitz will market products indexed on 20 different underlyings in crypto, forex, metals and energy commodity classes. Their correlation is not perfect, which provides certain diversification to the portfolio of Optionblitz. Optionblitz has no intention to leverage on this diversification.

To maintain further diversification of the inventory, we regulate maximum sizes of products to reduce concentration risk. It is needed because if a trader buys one product generating risk consuming whole capital, Optionblitz will become exposed to the risk of losing it completely. High granularity of portfolio with products sold at different times and underlying levels allows for better inventory diversification. Optionblitz aims to maintain the number of individual product units sold no less than 1000, hence we will limit the maximum notional of every single product to be sold per underlying. Specifically, for binary options, our maximum trade size allowed is $1000 and is never lower than $1, always subject to the size of the Capital allocated.

INVENTORY RISK AND BOOK ASYMMETRY

Optionblitz liquidity providers are the ultimate counterparty to traders buying our products. It is possible that under trending scenarios all traders will like to buy products in one direction. This will create directional exposure for Optionblitz, i.e., create inventory asymmetry. When traders purchase calls and puts at an equal rate uniformly across the time, then by the law of probability half of losing accounts would partly subsidise the payments towards winners. However, when purchase rates are asymmetric and positively correlate with price trend this will lead to more wins for traders and more losses for Optionblitz. Effectively, it is a delta exposure. To balance such situations and get compensated for taken risks, Optionblitz implements risk brackets and price adjustments:

The asymmetry of inventory is transformed into Adjustment Coefficient, which is added to the price at the offer. This add-on is sensitive to how much collateral is currently submitted due to purchases in one direction (either call or put). It is also sensitive to how much capital capacity is left at disposal of Optionblitz;

Adjustment Coefficient is applicable to prices of all products, but Turbo. In the case of Turbo, products are sold at par, but at a fee, which covers risk over the initial period. The turbos barriers are shifted at Funding rate per hour to compensate for the running risks over next periods. Hence the longer the position is held, the more Barrier is shifted.

EMERGENCY MANAGEMENT

Emergency market intervention simply consists of the ability of the protocol operator to suspend/enable markets. This action can only be applied to new traded positions, because Optionblitz cannot force premature settlement of any existing client position due to the irreversibility of crypto transactions.

OptionBlitz can be stopped manually in case of an attack or to reverse negative PnL trend.

Now that you have token a look under the hood of The OptionBlitz protocol, Click Here to learn about our Revenue Model and LP Rewards.