September 1, 2023

Perpetual Options

Learn about perpetual options.

Perpetual options work EXACTLY like perpetual futures - except for one key difference: They have a strike price.

If you're already trading perpetual futures, you'll have no problems getting accustomed to perpetual options as well.

If you haven't traded perpetual futures before, it might be advisable to start out with those first - as they are, conceptually, simpler than their options counterpart.

This intro will assume that you already have some basic knowledge of perpetual futures - including the concept of funding.

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Consider a standard version of the perpetual future. The payoff function for longs is a simple linear function of the futures price:

Payoff = (Exit Price - Entry Price) + Funding

Now, suppose we "optionify" this future by adding a strike price, and changing the payoff function to the following:

Payoff = (Exit Price - Strike Price) + Funding + Premium

This is perpetual options in a nutshell.

Notable is the replacement of Entry Price with Strike Price. For a perpetual option, your payoff no longer depends on your Entry Price (the price, at which you entered your position), but rather on the Strike Price (a fixed price, which is the same for everyone).

Also included in the formula is the Premium (the price of the perpetual option, when you bought it or sold it). If you sold the perpetual option, the Premium will be positive (you earned it). If you bought it, the Premium will be negative (you paid it).

The addition of a Strike Price and a Premium makes the payoff function non-linear. This is the key benefit of perpetual options: perpetual non-linearity.

Just like with regular options products, the Strike Price varies for each options contract. Each perpetual options contract will have its own unique Strike Price. The challenge, from a trader POV, is to pick the contract with the right Strike Price.

The payoff function we saw above works only for perpetual call options. For perpetual put options, we will need to modify the function slightly:

Payoff (Call) = (Exit Price - Strike Price) + Funding + Premium

Payoff (Put) = (Strike Price - Exit Price) + Funding + Premium

Just like perpetual futures, perpetual options involve a Funding Fee. The Funding Fee is charged at a fixed interval, and is calculated from the Funding Rate:

Funding (Long) = -Funding Rate x Abs(Position Size)

Funding (Short) = Funding Rate x Abs(Position Size)

If you're a perpetual futures trader, you'll already be familiar with the formula above.

If the Funding Rate is positive, the shorts will be earning the Funding Fee.

If the Funding Rate is negative, the longs will be earning the Funding Fee.

It is possible to construct a version of the perpetual call option that has the same payoff function as a standard perpetual futures contract.

To do so, assign a Strike Price of zero to the perpetual call option. Its payoff function will now be:

Payoff = (Exit Price - 0) + Funding + Premium

which, assuming that:

Premium = Entry Price

translates to:

Payoff = (Exit Price - Entry Price) + Funding

The assumption encapsulates the fact that the option should be fairly priced. The Premium paid or earned should be the market price of the underlying asset, at the time of the transaction taking place (Entry Price).

The Strike Price of a perpetual option is rarely static. Often, it will be dynamically calculated, based on a simple transformation of the market price of its underlying asset (underlier). This enables the Strike Price to change over time, and prevents it from going stale (a stale Strike Price is a Strike Price that is so far from the current market price that nobody is interested in trading it).

On Everstrike, the Strike Price is a fixed offset of the Exponential Moving Average (EMA) of the underlier. A selection of strike prices might look like this:

- 0.90 x EMA
- 0.95 x EMA
- 0.97 x EMA
- 0.99 x EMA
- 1.00 x EMA
- 1.01 x EMA
- 1.03 x EMA
- 1.05 x EMA
- 1.10 x EMA

By fixing the Strike Price of each contract to the EMA of the underlier (plus or minus an offset), the strike prices remain relevant in perpetuity and never go stale. This enables you to trade the same contract today, that you would trade in 10 years from now, regardless of whether the price of the underlier does a 100x.

Drift measures the degree to which changes to an option's Strike Price affects its intrinsic value (payoff).

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Explore related topics and concepts within the Everstrike ecosystem.

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