It is said in the documentation that " Options in FPO v1.0 are priced according to the Black-Scholes Option Pricing Model". From what I observed, ATM calls and puts on FPO are 50% more expensive than on CEX. OTM calls and puts can be 100% more expensive than on CEX.
I tried to replicate the pricing on FPO with the B-S Model. I found that BTC option pricing can be replicated with an IV of 100% ATM, while it’s 70% on CEX. In short:
Deduced IV on FPO
ATM IV on CEX
BTC
100%
70%
ETH
115%
85%
BNB
300%
Unknown
The documentation says “Decentralized oracles provide these crucial data feeds to the FPO v1.0 smart contracts.” Do these oracles provide the correct IV? It also describes " Moving Average IV and the IV Surface Mapping". But the resulting IV seems a little bit high.
Given the pricing, how does FPO attract serious option buyers and generate income for the pools?
The Current Anchor IV feed is from Deribit with a moving average of the average of several most liquidity ATM options. Then with this anchor, the model applied a mapping methodology for the IV surface as mentioned in the documentation.
Also, considering the options are American type on FPO, different from the European ones on Deribit, it is possible that the pricing is sometimes higher than those on Deribit.
Also, considering the shared liquidity in the decentralized model, it can provide very little price slippage compared with most centralized exchanged. Also, please note that with a cheaper pricing model for options, the pool can be exposed to higher risks, compared with incomes from option premiums, especially in the recent market bull runs.
This model is not only innovative in decentralization but also providing a new liquidity and pricing solution that are not seen in traditional finance.
We noticed the problem you said existed, and the team keep digging into the problems in options pricing in recent months and trying to find a better way to balance the interest of the options holders and pool participants.
Thank you for your reply Ryan. I am currently providing liquidity in the FPO pool. But I hesitate to hedge large positions of LP in other pools, for example ETH/USDT, BNB/USDT using FinNexus because it’s not cost effective compared to CEX.
FinNexus has its advantage when someone needs to hedge an LP with say 0.5 ETH and needs 0.0555 put of ETH because the minimum order size on Deribit ETH option is 1. However for medium to large size liquidity providers who need maybe 10 to 50 puts, Deribit is definitely the better choice for now given a 50% price difference for ATM options.
You mentioned risks in naked options. Have you considered offering different option strategies for purchase and assigning different risk factors to them?
The pricing of ETH options on FPO are not attractive but still acceptable. However BNB options seem to be too expensive with a deduced IV of 300%. I could only hedge my BNB/USDT LP with an ETH option and hope that they have good correlation as there is no other suitable BNB option.
I do hope FinNexus succeed in the long run as more and more institutions enter DeFi and realize the importance of option. But the current collateral utilization is too low especially on Ethereum.