Earning on Your Crypto When the Market is Moving Sideways

Covered Calls and Cash Protected Puts

David Duarte
11 min readDec 9, 2022
source: Tradingview

Users that hold crypto assets normally don’t just settle for leaving them idle in their wallets and want to earn some income in the form of a yield. It can be that users just want a yield on their existing assets but some users buy a specific asset, not necessarily because they believe in it, but because the yield on that asset is very high.

Less financially literate users might think that not earning a yield on your asset just makes your holdings constant, but they ignore the inflation present in many cryptocurrencies. However, I will not go into inflation here and I’m going to describe a strategy to generate yield on your assets, while trying to explain what that strategy is and the associated risks.

DeFi is powered by the search of yield

Finance around blockchain has taken several forms over the past years, from ICOs, to stablecoins, to Bitcoin Futures, to DeFi Summer, to the explosion of NFTs and probably many more “fads” will come that we can’t event think of at the present time.

But let’s focus on DeFi… During the DeFi Summer in 2020, the concept of liquidity became even more popular, probably around the time Compound protocol released its own governance token, Compound (COMP), which was used to reward users in a process known as liquidity mining. Also, Uniswap V2 was released, where users could deposit pairs of tokens as liquidity providers and earn a yield on their assets, in the form of trading fees.

At that time, many similar protocols were created on several chains and were basically forks of Uniswap. It was popular to see estimated APR (Anual Percentage Rate) in the order of hundreds of percentage points to provide liquidity to pairs, including newly created and iliquid tokens.

Pick at random a protocol token created during the summer of 2020 and plot it. Chances are you will see a graph like the one below.

source: Coinmarketcap

Users were incentivised to buy the token and become liquidity providers because the estimated yield for providing that liquidity was very high, in some cases 300%+ APR. But even that very high APR from the locked value wouldn’t make up for the inflation, as you were paid in the same token of which total supply was growing constantly, and many users would just cash out that return anyway. Not only would the asset bought to earn a higher yield be worth less, but because it was staked in an AMM pool, users would also be affected by impermanent loss.

But recently, maybe since last year, a more “sensible” way for retail DeFi users to earn yield came up, with Decentralized Option Vaults, or DOVs.

With DOVs, the yield users get on their assets is organic, and there is a concrete and reasonable explanation for that yield. In a DOV, users deposit their liquidity in a pool, in the form of an asset like BTC, ETH or SOL, or alternatively a stablecoin.

The pool, that is specific to a particular asset, then sells options on that asset on a regular basis with out of the money (OTM) strikes and it’s the premiums of the sold options that make up the yield of the pool.

Underlying Option Strategy

The underlying options strategy in these pools are basically Covered Calls in the case of depositing the assets, like ETH or SOL for example, or Cash Protected Puts in the cash of depositing a stablecoin.

In the case of a Covered Call, the user sells a call option while also owning the underlying asset. The plot below shows the exposure profile of a long position in the asset, of a short position in a call option and the combination of the two.

In a Covered Call strategy, the P/L at expiry below the strike is higher than the simple position in the asset, due to the premium received for selling the option, but the gains will be constant above the strike, since any gains in the asset will be offset be the short position in the call.

source: Author

The Cash Protected Put strategy consists in selling a put option while setting aside enough cash to buy the underlying asset at the strike. The exposure profile at maturity is shown in the plot below.

source: Author

Options Strategy in the DOVs

The simple products available in most of the DOV protocols are basically pools to enter into Covered Calls when depositing the asset, or Cash Protected puts when depositing a stablecoin.

Obviously, by selling options in any of these strategies, there is the risk of them being exercised, which in the case of the Covered Call would result is selling the asset which had originally been deposited at the strike, and in the case of the Cash Protected Put would result in acquiring the asset with the deposited stablecoin at the strike.

However, because liquidity providers can withdraw in the same denomination as they deposited, either the asset in the case of call or the stablecoin in the case of puts, what happens is a cash settlement, where one sells at the strike and buys at the (higher) spot in the Covered Call, and one buys at the strike and sells at the (lower) spot in the Cash Protected Put.

So users should understand that when they deposit in any of the products in a DOV protocol looking to earn the interesting double digit yields, the capital is NOT protected, and they may end up withdrawing less capital than they deposited.

Where to Trade

Although these products have become popular in DeFi, and there are quite a few protocols on several chains where users can earn a yield by selling options, it’s also possible to trade covered calls and cash protected puts in CeFi, on exchanges and digital asset platforms.

Let’s look at a few examples for each type of venue, DeFi and CeFi, with the same product - a Covered Call strategy — with prices taken at the same time, December 9th 2022 around 10h44, in order to perform a direct comparison.

DeFi — Protocols

On DefiLlama, we can lookup the TVL of DOVs under the DeFi Options category. Not all of the protocols listed there are strictly DOVs and the most popular ones, in terms of TVL, are Ribbon Finance and Friktion, and the most popular chains are Ethereum, Avalanche and Solana.

source: https://defillama.com/protocols/Options

Ribbon Finance has option vaults on several chains (Ethereum, Avalanche and Solana) and on several underlying assets. Below we see two of the products with ETH as the underlying, a Covered Call strategy on the left where users can deposit ETH and implicitly sell a call on ETH with a strike as $1450 and a maturity of one week, and a Cash Protected Put strategy where users can deposit USDC and implicitly sell a put on ETH with a strike of $1100 and a maturity of one week.

source: Ribbon Finance

The yield of each pool is basically the premium of the sold options converted into an APR.

In this protocol, as with almost all other DOVs, users can deposit either ETH or USD based stablecoin and on a weekly basis (Fridays), an OTM strike is chosen, typically around 15–20%, and an auction is held where market makers bid for the options which are filled at the highest available price.

The information on the auctions, past and upcoming, is available on the Ribbon Finance website.

source: Ribbon Finance

From this information we can see that the option was sold for 0.00325 ETH, which makes the announced estimated APR for the pool, 27.18%, slightly misleading. However, if we look at the tooltip next to “Total Projected Yield (APY)”, it says that the yield is the 4-week average of the weekly yield, and doesn’t include any losses incurred.

The correct yield on the ETH for the weekly deposit should be around 17.19%, which results from the spot price of $1283, a premium of 0.00325 ETH and 6.9 days to expiry. (6.9 because pricing was at 10h44 and the expiry is at 9h00).

17.19% = 0.00325 ETH/ (6.9/365)

Friktion Finance is on Solana but has a pool with ETH (Wormhole) as the underlying. At the moment of taking these screenshots the active strike of the pool was not 1450 but instead 1400. This should obviously translate into a higher yield since the option strike is closer to the current spot price, and therefore worth more.

source: Friktion Finance

CeFi — Exchanges and Digital Asset Platforms

Some exchanges and digital asset platforms also offer essentially the same yield as a product. One difference here is that there is no cash settlement at expiry and the user might end up with a different asset if the option expires in the money.

Binance offers the yield from selling options as its’ Dual Investment Product, for a limited set of coins.

source: Binance

For a trade date of 9.12.2022, when the spot price was $1283, the APR for depositing ETH with a strike of 1450 and an expiry of 16.12.2022 would be 11.37%.

source: Binance

Huobi also has the same product, but didn’t have the 1450 strike available at the cutoff timestamp for all the prices in this article. The strike of 1350 translates into a higher yield compared to the 1450 strike.

WhaleFin, a digital asset platform has the same product, but calls it Dual Currency, and although it normally offers a slightly higher APR than other CeFi platforms for the same details, at the current moment, with a strike of 1450 and expiry of December 16th, it offers a lower rate (7.93%).

source: WhaleFin

WhaleFin also offers the possibility to subscribe to the Dual Currency Deposit through its API. In a future article, I might show how to trade a range by creating a gridbot strategy with a few downside and a few upside options positions of a dual currency deposit that are rolled every day.

Disclaimer: I used to work for WhaleFin (Amber Group) but have no current affiliation

A reader with a bit a knowledge of financial products will notice that the products and strategies discussed above are very simple and can be easily set up by manually executing the positions on any exchange that has vanilla options as a tradable instrument.

Deribit is one such exchange, where anyone can sell vanilla calls or puts, as long as they have the appropriate collateral. However, appropriate collateral would be what the user would have to deposit in the DOV pools or CeFi traded products anyway.

To replicate the yield of our example, the user would sell a call on ETH for the 16 DEC 22 expiry with a strike of 1450. The listed Bid price (where the user can sell) at the same time as the prices above was 0.0030 or $3.85.

source: Deribit ETH Options

This would translate into an APR of around 15.87%:

15.87% = $3.85 / ($1283 x 6.9/365)

Final APR and Price Comparison

So for the same (market) exposure and the same product, a Covered Call strategy, the table below shows the APR offered by each of these venues. The rows are ordered by strike and then the APR that one can receive.

source: Calculations by Author

With the prices achievable on this particular date, trading the strategy on Ribbon Finance would offer the best yield, beating even trading the options manually on Deribit. This is obviously assuming that you are a price taker on Deribit and you would sell the call at the bid. From the image below, showing the bid/ask on Deribit at the time of the auction close, we can see that the options on Ribbon Finance were sold close to the mid.

source: Deribit — BID/ASK for 16 DEC 22 Calls on ETH @ 1450

Next in order, is Binance and WhaleFin, that offer a lower APR essentially because of the markup these entities put on the options being sold. These CeFi entities offer not only a lower yield but also offer a different (higher) credit risk since one has to trust the counterpart, which not everyone is willing to do, specially after the surprise of what happened to FTX a few weeks ago.

They do however offer the commodity of ease of use and it’s no surprise there is a fee there, since everybody knows that if you buy a chicken in the supermarket and roast it in your own oven, it will be cheaper than buying a roasted one.

DeFi is the winner in this particular case with an APR above Deribit and other CeFi platforms, while also offering the increased transparency and trustfulness of a Decentralized Protocol.

But I would advise the reader to do his own research and not only understand where he is putting his funds and where the yield comes from, but also compare equivalent alternatives out there. I have looked at these prices many times and the relative order of the listed alternatives can be quite different.

To sum up, and to explain the title of this article “Earning on Your Crypto When the Market is Moving Sideways”, these strategies are a good way to earn yield on you crypto but bare in mind that the market can’t move past the strikes of your options.

The yield on your investment, if the market is volatile or is trending, can easily become highly negative, because the premium of the sold options will serve as a small buffer if the options expire in the money but the potential final negative PnL can wipe away many weeks of option selling.

The expression in financial markets for this is “picking pennies in front of a steamroller” pointing to the idea of very high risks compared to the rewards.

There are other reasons to go for these strategies, besides just looking for yield:

  • Cash Protected Put — you might be accumulating a certain asset and you wouldn’t mind buying lower than the spot. You can sell puts and earn that premium. If they get exercised, you might have wanted to buy the asset anyway
  • Covered Call — you want to sell an asset you own if it rises to a certain price. Sell a call on that asset and earn the premium. Worst case is that you sell where you would have sold anyway

(please note in both these cases, that you give up optionality. “you would have sold or bought anyway” but if you sell the option, the choice is no longer yours to make if the price goes beyong the strike)

I hope this was useful in understanding the yield and risks of Decentralized Option Vaults and products that involve selling options in general. Feel free to reach out and connect if you have any questions.

Thanks for reading and stay tuned for more!

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