AOTP Principles
Last updated
Last updated
Building on the Black-Scholes option pricing model as the theoretical basis and implementing dynamic option hedging (Delta Hedging) methods as the market making strategy, Asteria designed its options market maker dynamics: the three-dimensional plane (similar to Uniswap's X*Y=K trading formula) through model optimization.
Delta Hedging of Option Market Makers: options trades quoted by OTC options market makers. Investors purchase options based on the quoted prices as the primary trading mechanism. Options market makers use the Delta Hedging strategy for flattening their market exposures to obtain market-making income similar to fixed income.
Delta Hedging (Delta Neutral Strategy) is the most critical hedging strategy for option market makers. The price of the underlying asset is the main factor affecting the cost of the option. Then, the profit and loss of holding the underlying assets equal the holding of the Delta unit under the same conditions. Since the delta of an option is constantly chugging, the size of positions held by the underlying asset is continuously adjusted as the delta changes. In the end, the P&L of the underlying asset holding is the same as holding the options. That is to use the dynamic holding of the underlying asset to copy the P&L of an option, so delta hedging is also known as the delta replication strategy of options. After the options market maker sells the option, hedging occurs by copying the P&L of the option through the Delta replication strategy, which is called the Delta Neutral Strategy.
Delta Hedging and Volatility Trading: Directional risk or Delta risk is the most critical risk affecting option price changes. Therefore, users can hedge a significant portion of the option holding risk by limiting delta risk. But there is another critical risk that cannot be hedged, and that is the Vega risk brought by volatility. On the one hand, volatility brings directional risk; on the other hand, the degree of volatility also carries risk for any market maker. Since volatility is also constantly changing, the implied volatility, the actual volatility of the underlying asset during the hedging phase, and the volatility used in the dynamic hedging model algorithm, three of which combined determine the deviation between the delta hedging cost and the theoretical value of the option. Therefore, the dynamic hedging strategy of options is also called volatility trading because the ability of volatility estimation and prediction alters the cost of dynamic hedging by option market makers, also defines the level of non-directional risks. The Mathematical Basis of Delta Hedging can be seen in Asteria's Whitepaper.
The On-Chain Shared Liquidity Capital Pool is the innovation and core infrastructure of AOTP in the decentralized options trading framework. In traditional finance, professional institutions obtain fee differences by providing services such as designing complex financial products and capital custody. The profit sharing and risk exposure are often not transparent with retail investors, who usually neither get higher profits from significant returns nor endure the systemic risks brought by centralized custody and human mistakes.
By placing option market-making capital custody on-chain, AOTP substantially simplifies the user's participation procedure and lowers the investing threshold. Meanwhile, AOTP achieves openness and programmability on assets management and revenue distribution. Investors can obtain transparent profit sharing and have the flexibility of staking and withdrawing from the liquidity pool at any time to realize instant income. At the same time, the initial liquidity provider through IBCO (Initial Bonding Curve Offering) would also obtain the higher return of first batch liquidity mining with the growth of appreciation on platform native token.
The Asteria decentralized options market-making system analyzes comprehensive factors such as the liquidity of the underlying asset, volatility estimation, and current position structure to provide the inquiry party, the option buyers, with information on the prices and the number of tradable options contracts.
Asteria's decentralized AOMM supports creating and customizing most option structures in the traditional financial market to meet various application scenarios for different types of investors.
