Introduction

This research piece seeks to provide an overview of the options available on Katana and Friktion, which are both option platforms on the Solana Blockchain.

What are options?

Options are financial instruments that are based on the value of an underlying asset. An options contract gives buyers the right to buy or sell an underlying asset at an agreed-upon price with date expiry, without the obligation to. We will discuss the types of options and style of options below.

Types of Options

If you buy a call option, it gives you the right to buy the underlying asset at a predetermined price known as the strike price. The profit on this trade is the market price less the strike price plus the expense/premium of the option. If the underlying price does not move above the strike price by expiration, the option expires worthless. People who buy calls are typically bullish, expecting prices to move up beyond the strike price.

If you sell a call option, it gives you the obligation to sell the underlying asset at a predetermined price known as the strike price if the option is exercised by the option buyer. If the market price does not move above the strike price by expiry, the option expires worthless for the buyer. The option seller earns the premium for selling the option.

If you buy a put option, it gives you the right to sell the underlying asset at a predetermined price known as the strike price. The profit on this trade is the strike price less the market price plus expenses/premium of the option. If the underlying price does not move above the strike price by the expiry, the option expires worthless for you and you lose the premium for buying the put option.

If you sell a put option, it gives you the obligation to buy the underlying asset at a predetermined price known as the strike price if the option is exercised by the option buyer. If the market price closes above the strike price by expiry, the option will be worthless. The profit for the put seller will be the premium for selling the option. However, if the price falls below the strike price, the seller is obligated to buy the underlying assets at the strike price.

Option Styles

American options may be exercised at any time before or at the option expiration date.

European options may only be exercised at the option expiration date.

Introduction to Katana

(website/twitter)

Katana is a yield generation primitive built on Solana. The protocol offers various packaged yield products across various risk spectrums. It enables users to passively access the best risk-adjusted yields in the ecosystem without active management. It uses PsyOptions protocol to mint options in the backend and these options are sold in the OTC market. It has a current TVL of $40.55m, with yields from 8.29% to 95.49%.

Value Proposition

Yield generation on Solana is largely fragmented, a manual process and yields are mostly tied to liquidity mining programs. These programs might not be as profitable in the long term due to the mostly inflationary tokenomics of such tokens.

Katana provides a passive method to earn yield by automating option strategies for different market views and conditions. This makes the yields sustainable as yields do not come from liquidity mining programs. Also, the automation and optimization allow users to passively earn risk-adjusted returns through various strategies.

Being built on Solana also entails lower transaction fees, a friendly and improved user interface and experience as well as fast settlement time which is a natural fit for such products.

Team

Ayush is an experienced developer on Solana who has won two Solana hackathons. He won the Raydium prize at the Solana Season hackathon for Laguna Finance and the grand prize at the Ignition hackathon for Katana. He is an undergraduate student at Harvard, studying computer science and economics. He is on leave from school to work full time on Katana and was previously working as a founding engineer for Mars Protocol, incubated by Delphi Digital.

Eric is a seasoned DeFi developer who has previously built a DeFi protocol on Ethereum, managing the full-stack from idea to product execution. He graduated from Carnegie Mellon with a degree in computer science and math and previously worked as a software engineer for Addepar and Jump Trading.

Investors

Katana is backed by investors but they are yet to be announced for now.

Fees

None

Types of Options

Katana’s vaults allow users to sell covered calls (by locking the underlying assets) and also sell puts (by locking USDC).

Style of Options

Katana utilizes American options. This means that the options can be exercised at any time before or at the option expiry date. This is crucial as a spike in the price might result in the option being exercised. Each vault also has weekly expiration dates, which is on Friday.

Vault Strategy & Risks

The covered calls vaults accept the underlying assets as deposits and earn yield via an automated covered call strategy. The vault will deposit the underlying asset on PsyOptions and mint out-of-the-money calls in return. The vault then sells these call options on the OTC market, earning premiums as yield.

If the market price of the underlying is below the strike price at all times before and at the expiry, the vault earns the full value of the premiums and will repeat the strategy with the underlying being compounded.

However, if the price of the underlying is above the strike price of the option at any time before or at the expiry, the options are deemed to have expired in the money and market makers can decide to exercise the option for the underlying asset. This results in a potential loss in the underlying asset you have contributed. But, strike prices are chosen so that these events are exceedingly rare.

The put selling vaults accept USDC as deposits and earn yield via an automated put selling strategy. The vault will deposit the underlying asset on PsyOptions and mint out-of-the-money puts in return. The vault then sells these put options on the OTC market, earning premiums as yield.

If the market price of the asset chosen is above the strike price at all times before and at expiry, the vault earns the full value of the premiums and will repeat the strategy, with the USDC deposit being compounded.

However, if the price of the asset chosen is below the strike price of the put option at any time before or at the expiry, the options are deemed to have expired in the money and can be exercised by the market makers, resulting in potential loss in the USDC you contributed. But, strike prices are chosen such that these events are rare.

Vaults

TVL: $40.55m

*all put selling requires USDC as deposit **APY changes based on option and market conditions

Data as of January 17th, 2022 Sources: Katana

Introduction to Friktion

(website/twitter)

Summary

Friktion is a DeFi portfolio manager, built to perform across market cycles. It offers both active and passive portfolio management strategies, finding ways to maximize returns while providing volatility protection and yields in turbulent markets. It uses PsyOptions, Inertia and Traction to mint options in the backend and these options are sold in the OTC market. It has a current TVL of $113.27m, with yields from 11.4% to 100.6%.

Value Proposition

Friktion aims to help perform yield farming optimally by offering both active and passive portfolio management strategies. Friktion finds ways to maximize returns while providing volatility protection and yields in turbulent markets.

Being built on Solana also entails lower transaction fees, a friendly and improved user interface and experience as well as fast settlement time which is a natural fit for such products.

Team

The team is pseudo-anonymous currently, but this is the information we managed to dig up:

Previously worked on commodities trading desks at spot/futs/vol crude +products and carbon. Subsurface engineering degree.

Previously worked as a quant trader for a crypto hedge fund and at a US treasuries desk. Degree in computer science and mathematics.

Previously worked as a front-end engineer at PsyOptions and Swedish traditional finance banks.

Works on adding new products like native support and repackaging UI.

Investors

Friktion lab recently raised a $5.5m round from Jump Crypto, DeFiance Capital, Pillar VC, Libertus Capital, Delphi Ventures, Sino Global Capital, Tribe Capital, Castle Island Ventures, Dialectic, Petrock Capital and Solana Ventures.

Friktion has also brought on board industry-leading derivatives traders and market makers in Genesis Trading, Alameda Research, QCP Capital, CMS Holdings, LedgerPrime, Orthogonal Trading and GSR.

Fees

Withdrawal fee - 0.1% Performance fee - 10%

Types of Options

Friktion’s Volts (their vaults) allow users to sell covered calls (by locking the underlying assets) and also sell puts (by locking UST & USDC).

Style of Options

Friktion utilizes European options. This means that the options can only be exercised at the option expiration date. The switch towards European options from American options was to address the concerns of investors when the price of the underlying assets is near the strike price. Each volt also has weekly expiration dates, which are on Friday with the exception of SBR tokens which are biweekly.

Volt Strategy and Risks

The covered calls vaults accept the underlying assets as deposits and earn yield via an automated covered call strategy. The vault will deposit the underlying asset on PsyOptions, Inertia and Traction and mint out-of-the-money calls in return. The vault then sells these call options on the OTC market, earning premiums as yield.

If the market price of the underlying is below the strike price at expiry, the vault earns the full value of the premiums and will repeat the strategy with the underlying being compounded.

However, if the price of the underlying is above the strike price of the option at expiry, the options are deemed to have expired in the money and market makers can decide to exercise the option for the underlying asset. This results in a potential loss in the underlying asset you have contributed. Option strikes and expiries are algorithmically determined to maximize returns and minimize the chance of an option being called.

The put selling vaults accept UST & USDC as deposits and earn yield via an automated put selling strategy. The vault will deposit the underlying asset on PsyOptions, Inertia and Traction and mint out-of-the-money puts in return. The vault then sells these put options on the OTC market, earning premiums as yield.

If the market price of the asset chosen is above the strike price at expiry, the vault earns the full value of the premiums and will repeat the strategy, with the USDC deposit being compounded.

However, if the price of the asset chosen is below the strike price of the put option at expiry, the options are deemed to have expired in the money and can be exercised by the market makers, resulting in potential loss in the UST/USDC you contributed. Option strikes and expiries are algorithmically determined to maximize returns and minimize the chance of the underlying asset being assigned.

Volts

TVL: US$113.27mm

*all put selling requires UST/USDC as deposit **APY changes based on option and market conditions

Data as of January 17th, 2022 Sources: Friktion

Examples on how Crypto Options work

If you deposited 1 ETH ($100 for example sake) into the covered call vaults with the strike price being $110.

American Option - If the price of ETH is above $110 at any time before or on expiry, it will be exercised. If not, you will just earn the premiums/yield.

European Option - If the price of ETH is above $110 at expiry, it will be exercised. If not, you will just earn the premiums/yield.

In the case that ETH reaches $120 and your option gets exercised, it means that your ETH is sold at $110, which is the strike price.

You lost $120 - $110 = $10 of upside in this case as compared to just holding the asset. The $110 you received from the sale is converted back to ETH, thus you receive $110/$120 x 1 ETH which gives you 0.9167 ETH. But that is not all, you still have the premium/yield on top of this. Thus, your total ETH would be 0.9167 ETH + yield.

In dollar terms, you still gained from this. Your total gain would be the strike price $110 minus the initial price plus the yield. Thus, your total gain in dollars would be $110 - $100 + yield = $10 + yield.

If you deposited $100 USDC in the cash secured put vault for ETH (assume 1 ETH = $100 at the time of deposit) with the strike price being $90.

American Option - If the price of ETH is below $90 at any time before or on expiry, it will be exercised. If not, you will just earn the premiums/yield.

European Option - If the price of ETH is below $90 at expiry, it will be exercised. If not, you will just earn the premiums/yield.

In the case that ETH reaches $80, your option will be exercised, it means that you have bought $100 USDC worth of ETH at the strike price of $90.

You now have $100/$90 = 1.11 ETH + yield. In dollar terms, your 1.11 ETH + yield is now only worth $88.8 + yield.

Takeaway and possible Alpha Leak

Options are very effective as a source of passive income especially when we experience a ‘crab’ market. It is also rather effective as a tool to hedge against price actions.

Some might say that these options would limit your upside as seen from the example above. One method of eliminating that barrier would be to open perpetuals at the strike price in order to capture all the upside/downside potential as the market moves up or down.

Both Katana and Friktion do not currently have tokens and it is expected that a percentage of tokens may potentially be airdropped to users based on the size of their deposits as well as the duration of their deposits. This is referenced from ThetaNuts which has the same product coverage and ranges and will have an airdrop based on the above criteria.