Trading Options 101 - with Josh from Orthogonal, Su Zhu, and Hasu

Transcript

hey welcome back to uncommon core where we explore the big ideas in crypto from first principles today i'm sitting down with suzu my friend and co-host and josh of orthogonal shading josh is one of the most experienced options traders in crypto and we had a very interesting and wide-ranging conversation topics we touched on today include how options work differences between options and futures different strategies for using them in crypto as well as what josh thinks about options trading platforms in d5 please enjoy so hey welcome josh um why don't you

introduce yourself real quick and um what you guys do over at orthogonal yeah thanks for having me it's uh very exciting to be on this podcast i listen to it religiously when it comes out so we are you know digital digital asset um focused hedge fund we run three main buckets of risk i guess you would say uh we do a lot in options uh making and taking that we predominantly take uh we do some market neutral arbitrage stuff in both cfi and d5 so that could be anything from farming to you know purpose physical arbs or other types of apps um and then we do some systematic trend following stuff as well

so that's kind of gray box black box over a few different time horizons uh focused mainly on btc and eighth but you know we'll do some other assets if they're if they're moving a lot and we kind of allocate our risk between those three buckets you know depending on the opportunity set at the time so i i take it you you have a background in traditional finance before coming into crypto yes yeah so um my background before crypto was i was a macro portfolio manager at an internal hedge fund down here in australia at the bank i was working at so that was kind of like a classic uh macro prop

desk where you came in at the beginning of the year and had some limits and some stop losses and and went for it uh i did that for several years that desk was kind of being wound down and so then i went into crypto i joined a firm digital asset capital management working with a guy named richard galvin uh as the head of trading so i had a great time there for a couple years yeah we did a bunch of stuff i think we're both huge fans of richard right yeah i love richard we should definitely have them on sometime yeah i introduced richard to uh carl and sue if my memory is correct yeah a long time ago um so yeah so i was at i was at dakum uh for two years

and then beginning of this year i left there and set up my own own firm with a few partners so my partners from traditional traditional markets as well from predominantly backgrounds one from morgan stanley trading fx options one a senior guy who was at a lot of different shops but he was at uh you know firms such as blue crest as a senior pm there we've got another guy who is a quan slash dev who you know came from some japanese uh some of the large japanese banks so now we are we're four four strong uh and and chugging away hmm but i mean i love your accent by the way thank you i don't know too many people

from australia so i don't know i don't know if maestro accident is a lot australian or a little australian yeah i'm not sure it's but it's very easy to listen to for sure so how is the crypto scene actually in um in australia did you guys so you guys manage your own balance sheet but also have some outside capital right so did you raise from australia how's the scene over there yeah yeah that's true yeah so we run our own balance sheet um we do some slightly different stuff with our own balance sheet to what we do in the fund uh we do like for example we'll test test strategies out like systematic strategies and stuff with our own money before putting external people's money into them just to make sure they're all working properly

uh we do a bit of vc stuff as well where it suits strategically in terms of our fundraising it's not much from australia actually uh predominantly from asia uh but you know more they're kind of classic um hong kong singapore you know china and we have uh some funds from from uh you know europe and and and uh the amer america as well but i mean yeah the the australian crypto say and i would say it's pretty it's pretty good i mean obviously melbourne is a huge hub for d5 uh and there's you know some some stuff i guess happy in sydney and then you know sydney we have i mean a cooner who are

if not the biggest certainly one of the biggest uh options market makers in crypto they have a sydney office so there's there's some there's some option stuff at the very least happening in sydney um there are options a good change of topic so um that's actually the the main reason i wanted to have you on um because you're one of the biggest uh options traders in crypto uh mainly on the the taker side um and um it just i think you have a very like you're very very good at making things sound understandable and simple so i really admire that um love following you on twitter for sure so yeah um we've we've done an episode

on um sort of a 101 on perpetual swaps a couple months ago um actually i i interviewed two and that was our most uh popular episode back then so since then people have a lot of people have requested that we do something on options as well sort of give people a basic intro so um can you describe in your own words uh what an option is and how it works yeah sure um now i'll probably do a terrible job of keeping things simple but uh the classic definition would be that it's a derivative to give you the right but not the obligation uh to transact at a certain price at a certain time in the future so if you uh buy uh

a call then and let's say it expires in in a week's time and the strike is 20 000 uh dollars per 1 btc then you have the right but not the obligation to buy you know the amount of face um worth of btc that you bought in that option so the option was for 10 btc and the spot market ends at 21 000 after a week you can buy 10 btc at 20 000 and you'll make your profit of you know a thousand dollars times by 10 and likewise if you're the seller then um you know you sell the option so if they want to exercise you have to and you you've got the opposite position i mean in practice

in practice there's no like oh i'm not going to exercise er if you're in the money you get exercise and if you're not in the money you don't but but theoretically very basic question so when when i buy a call option and it expires in the money and uh do i like how does the settlement work compared to like a futures contract uh well different platforms in different markets will sell you in different fashions like some will cash said or use some will physically physically settle you for an exchange on derebit how the settlement process works is like half an hour before expiry you have your delta from the options and it will then tell you what

your delta of your um derivate account will be after expiry so if you're delta hedging your book uh you're like keeping your um directional exposure to a minimum you will use that period to adjust via perps or otc or futures or whatever your position such that it's you know flat at the end of that period uh if you're just outright have the option then basically at the end of the period at settlement time all your exposure goes away and you get your btc or eth payout in your account so it effectively cash cash settles in okay so if if if i buy the the option to buy like a btc at um

at 20k and it it ends at 21k and i don't actually need to buy a bitcoin right i i cannot no you don't well no you don't have to um you don't have to just get that p l in your account basically oh yeah okay so um going back to your original explanation so um i picked up three um yeah three key terms i guess that maybe our listeners should understand the first being kind of the strike price right um the second the expiry date start this this the strike price is basically where you can buy or sell the uh the asset yeah correct and sometimes you'll uh you sometimes

you'll see people refer to the strike prices k so like on twitter or wherever the strike price equals k um okay and then the the expiry date it's just the date when the option expires right and yep and the third being kind of the premium right what yeah yeah premium is is yeah the the cost of the option um not like so if you buy you know 10 of an option and the option costs a dollar then your premium will be 10 spent effectively what what you can if you buy a call and it's limited loss you'll long it then that that 10 premium is your

you know max loss for that position assuming no delta hedging so i would assume that our listeners are like all of them are familiar with kind of how futures work because we've done a very uh intensive episode on that so how how would you describe kind of the differences between between the two types of derivative i think one way you could describe them assuming that you're we're just talking about kind of longing options uh and not shorting options is you know when you and if you don't use a stop loss on your future position then your futures position is obviously unlimited loss and you can end up

getting liquidated or whatever if you're in an option assuming you don't use the entire account balance on that option your max loss will only be the money you put down so that's one aspect i think that's that's pretty different is that you have a limited loss versus an unlimited loss unlimited in the context of crypto you always mean busting your account right yeah zero negative 100 um what's another difference let me think of um so do you reckon you get more leverage on a per unlike a highly levered perp or on a call probably on a call right i think a call also i think the the biggest value of a call over a

perp is really that your stop-loss is defined better right so that you don't you kind of don't get wicked out um yeah you can set and forget it almost so i think that's probably the biggest difference another difference between i think a future or a perp and an option uh could be if you buy a perp a market goes up you know you make money if you buy say an option that is a thousand dollars out of the money and the price goes up by six hundred dollars that option will you know eventually that option would decay to zero and you you're still out of the money expiry

and you'll suffer your total loss you know of the premium so while the options have a limited loss they're you know on an expiry you'll obviously make money during the option as it rallies but uh in an expiry sense you're you don't have that guarantee that you will make money if the market rallies because the market has to rally you know three your strike and through your strike by enough you know technically to like cover any of your costs as well they're probably the two main differences yeah i i i feel like especially for someone who doesn't have kind of the automatic trading setup and it's kind of hooked directly into the exchange api and can basically has a manual kind of stop-loss

system i think that's um it's a very valuable feature of options uh basically that it's kind of set and forget because i've i've used stop loss i've tried to use stop loss in futures both on bit max and ftx and um well it's it never really works the way you expected right yeah yeah yeah well the wicks in crypto are real even without mix so being so dominant they're still uh you know this they're still pretty serious when they want to be yeah not just not just the other weeks for sure but also when the market actually gets to the price where you set your stop loss you're basically never getting filled

there because on the way there there might also be liquidations queued up right so you you're not first in the cube basically to execute yeah i'd agree with that i mean obviously you know if you want to uh if you want to short short options that's that's a different ball game uh you know with very different risks but if we're talking a lot long options then you get you know you get plenty of leverage especially if you buy what you would call like a wingy option which is an option with a low delta or like or a low probability of going in the money you know you can buy a lot of those types of options for a small amount of cost um but you know only lose what you put in but

yeah there's no guarantee that uh at expiry time you're uh you were right but you've got a long time that's i guess in a sense that means you've just got a long time before you have to worry about us like um effective stop triggering yeah so you touched on long options um and kind of the short side being the the way more risky one so that's so that's something that took me uh a moment to wrap my head around right because if you're used to a few chests then kind of the the opposite um the kind of party of every long is kind of a short red like if you if you look a long view on the market then you just long the future if you have a negative

view on the market and you can short the future right there's some options there's like you can you can buy a coil uh or you can sell uh a put right and also have very different risk profiles yeah yeah they give you you know like they may give you a similar delta exposure so your you know your effective um like spot position but yeah they'll give you different the other greeks they give you will be very different uh in like a first order sense so you know if you long the call you have your long delta and you have some long gamma and you have like you pay theta uh and you're longer a little bit yeah

yeah and you know if you sell the put you still have the long delta but everything else is the opposite basically so your the scenarios you want that making money are pretty different yeah every time you sell something like whether whether it's a put or a call then your loss is unlimited and every time you buy something then your loss is limited to the premium you paid right correct yeah yeah i think the interesting i think an interesting like philosophical way that i've had options explained to me in the past that i think might be useful for beginners is that when you're buying options you're long volatility and when you're short options you're short volatility

and so when you buy options you're hoping that the market will move more than other people expect it to move right so when you buy that call you're betting that the price of that call the the price is not reflecting as much upside volatility as you expect so in other words you choose the option to express that view because you think that that gives you the most upside and same with the put you by the put when you think it's um when you think that uh the market's not pricing it as much downside volatility as you expect so it's really it's really about your own view on volatility and whether or not you think the market

is overpricing it or underpricing it and that kind of gets to what josh just mentioned now about greeks right where he talked about theta gamma and vega these are all just different ways that you can quantify your exposure to volatility so i think i think framing it that way you know where you're either long ball or short ball i think it's a good place to start to to understand what you're what kind of risk you're taking on when you do a strategy yeah i agree with that i think you could you could add as well that in options there are a lot of different ways to trade you know trade options you you know you can just buy a single option and just worry

say you buy a call you know just worry about did i buy a call that i think is reasonably priced uh and do i make money on it or you could you know be much more complicated and you know analyze a bunch of you know kind of option specific metrics to see if you know that was a good outright um way to trade you know a delta view or if you don't want to trade options for delta um you know as a convex way to get a good payoff for say a long option position then you might you know run a relative value book where all you care about is you know the voles sometimes you don't even care if it's a call or a put you just care about you know what that ball is you know on the curve or the

surface and you have multiple long and short options at any one time across you know every wrist bucket so you can make it simple and you can make it complex and i think it depends on you know what you want to get out of the what you want to get out of it really and what your expertise and experiences so you mentioned um you mentioned that that like philosophically one way to think about option string is kind of betting on volatility right relative to kind of what the market expects and the the first time we we talked about options ever on this podcast was in the context of uniswap appearing right so um when people put two assets

into a pool um they're kind of rebalanced by the market and in terms of exposure it is like selling volatility right so they they give up kind of the the extreme top side and the extreme downside um and uh yeah kind of the volatility is kind of compressed so um you suggested that one way to hedge that exposure which is we also call it permanent loss typically um would be to uh to buy volatility actually right using a combination of two options so i want to get into some of some of these things people use options

for in crypto um maybe going through the yeah the different stuff both like very simple uh like one directional stuff and the more kind of complex combinations of products that people might be interested in i mean i think you can probably separate them into uh hedging and specular i hate g and speculating um to start with so you know speculating is kind of just buying or selling you know an option based on whatever your prevailing view is and then hedging might be like you know the um amm example where your negative gamma uh from being an lp on the amm

so you say buy some strangles or straddles and you try to structure it in a fashion whereby like your negative gamma is mitigated but you still uh net earn some sort of money um you know from fees or yield uh you know yield being given to you in the form of a token or whatever gamma if uh gamma being the rate of change of your notional position for a moving spot so you know if you have um x amount of gamma and spot goes from one to uh two your your position won't be the same it'll be you know

a function of the gamma position i don't know if i explain that very well but what kind of options are in a stranger so strangle is just a long a strangle and a straddle are kind of the same thing in terms of what options they are so straddle is two options i put in a call of the same strike and a strangle is put in a call that are different strikes so if you're you know trading um say in a macro in the macro world and you just want to buy like a grunty vole position you might go in and say hey i want to dns

thanks what's your vol and that stands for delta neutral straddle so you basically buy like the at the money put and the at the money call you have no delta exposure you just have like a large bowl exposure uh if you want to buy if you think that the value in options is more on the out of the money stuff than that at the money stuff then you might buy a strangle uh in which case that is still delta neutral if the strike if the deltas on the strikes the same obviously but then you might buy the 25 to put in the 25 delta call so they give you yeah they give you kind of the same risks in the sense that your long your long bowl and you pay a premium to

own those options but like the second level would be that you know you have different um risks in a local or local sense or if the market moves a lot so you know the you'd buy the strangle if you thought the um mark was going to move a lot and the out of the monies were very cheap but if you just thought the market was going to kind of move locally but the vole was cheap or you thought the smile was fair i.e the value of the out of the monies compared to the out of the minis then you might go the uh you might go the um straddle so yeah you separated them into speculation and hedging and i guess that most speculators would would take play

only the long side of options right so kind of coil buying i think you see a lot actually i think you see a lot of speculating in option selling for yield i think that i think that's one thing that's changed in the market i think like maybe um 2019 2018 even you saw a lot of the a lot of speculating was just people punting along options now i think there's been a bit of a shift where like people are quite keen to earn some yield so they're kind of they'll come in and sell them or sell them in some sort of product uh i think that's that's changed a bit uh yeah i mean you had them down here it's a third category yield enhancing so yeah well i mean that would be that is speculation but it's just like a nicer

it's yeah it's nicer word you're totally right yeah yeah exactly i guess for i mean there are lots of good examples i guess hedging in macro world if in terms of using hedging uh options for hedging crypto yeah so miners miners is the classic one yeah where they buy puts um they either buy puts or they sell the risk reversal which is buying puts and selling calls um so that's the classic uh the classic miner hedge another one might be like a a fund or an investor that's you know long biased or long only and wants some downside protection so it's happy to buy some puts

and you know if you get um if you get the market for market tanks and so b you've protected yourself and if you lose the premium you're fine because you want the market to rally anyway i think another form of hedging that um people don't think about as much but kind of like bullish hedging if you'll allow me that meme is when people think that their fund is going to get more subscriptions or a lot of money is going to come into their fund to buy bdc then they may buy a call spread or or buy calls to hedge that inflow because they'll say like i want to try to lock in a good price for those people like you know if the money's already confirmed but just the fiat hasn't hit yet uh so i think you know you also see like

call buying in that context and that's actually quite common in equity markets right where uh people will buy calls to hedge their expected inflow uh the next month uh things like that so you know hedging can also be like hedging fiat into bdc like let's say you're a trading firm and you expect to make x amount of bdc next month on a trade you may want a hedge and just lock it in but you may not have the capital yet to go long spot so you don't want to get liquidated on long perps then you may buy calls instead because you know you can fully fund that in a day once you get the cash from your proceeds for instance i think i think you could even extend that too this is going to maybe sound really silly but like

um hedging your longs with calls whereby you know let's say you're let's say you're bullish and you've got a large pert position um but you're also terrified that you know the market's going to have some sort of nasty pullback you can you can take some of that premium or something some of that profits and put it in a call instead so you know if unless you buy it you're not going to be buying a call that is the same delta or notional position as as your spot position is so you're reducing your directional risk you're lowering your p l um by putting it into that call so in a sense that i would say is really a hedge i.e like it's definitely

it's not yeah it's not necessarily profit maxima maximizing but it's like um it's vole lessening like p l voles yeah yeah you're basically creating a synthetic put for yourself right like you're yeah you're using your your what you want is you want to be able to protect the price that you can get out of your deltas at by changing it into a call so i think that's also i guess another interesting example you know tying into yield farming is back in july august when you know what wi-fi had come out and and there's a lot of good farms stable coin farms with curve and compound and so on i think a lot of b2c denominator players that that we speak with as well as ourselves

you know it was interesting to think like you know you can you can sell your bdc to usd uh farm with it at 100 apy on huge size and also then buy calls and the calls get you your bdc exposure back and the yield from your yield farm kind of pays for that call theta and yeah and so you're just left with this may be too much alpha leak but i think yeah we did that is we did that as well these farms are these farms are mostly dead now so i'm i feel okay talking about it yeah i think it's fun now but but yeah i think i think like thinking back to like that that's one of the most obvious trades

and it's a and it's a hedge where you you basically have no downside because even if bitcoin goes to 1k you don't care actually you probably make money uh yeah i think in that scenario well certainly if you're liquidating if certainly if you're liquidating your farms into fiat and btc gets smoked that's and you're farming like a stable then that that's a great outcome because you'll lose a bit on your calls that's fine whatever but um you uh will be able to buy a lot of btc back cheaper with the fair you have accumulator right and i mean if the market does tank you don't even necessarily if you're you know like a sophisticated trader you don't even necessarily need to sit on that core delta right you can just go and hedge it and try and get the deltas back lower

exactly yeah yeah we did that as well i think that was kind of no-brainer yeah we touched on all selling and that there are a lot of products now where people are kind of exposed to that so i think binance binance has a pretty popular one i'm not sure if they call it like dual savings account or something and then matrix port i think also has a has a product in that direction where you deposit btc right and then there's a um they say calls so calls on that btc um so what do you think about that kind of um product in general i mean i think that like selling calls is great until it's not

and then it's like really not at all very good well i mean think of it like if my if your i guess probably depends a bit if you're cupboard and what strikes you're selling and what premium you want so for example you know if you're selling calls in a market that's grinding higher and there's no real prospect of like any explosive up move in the short term that's one thing if you're selling calls you know with btc at 19.9 k and it could be at 22 in three minutes like that's a whole different ball game and i think also think of it like if you want to earn x yield say your long xbtc and you want to earn y yield you can

sell a high delta call a call that's closer to the strike in an amount that might notional match your b2c so you know you have the btc and you'll be okay um you just cut off the upside which everyone is kind of here for but that's fine and then but if you then go oh you know what i don't actually want to be selling it might be to see that level but i still want to get that premium then you end up selling a further out of the money call but you have to sell it in much more size to get the same premium so you know you can be in this situation then where you're not actually fully covered anymore and i've heard of some firms that have done this like then you're actually just outright short calls because you're long 100 btc but

you short 200 calls and then you have a you have at that point of you know like a super wingy um position with a lot of like a volvo and other kind of more complicated greeks on it so i think like the cover call is always going to be around and it's you know i can understand why i think there's times and places for it and it depends a bit you know if the ball is up there at 200 then like sell all the cover calls you want because like it's super worth it if the balls are like 30 then i don't think it's a very good idea i think also like covered call just as an idea you know it's it's very similar to being a uniswap or sushi swap lp it's it's not good or bad on its own because it's also about what

you would have done instead anyway right like like if you would have worked to sell wall on coinbase at 21k then you might as well sell a 21k call right yes you may never get if i get there yeah because you because you would have put the offer there anyway so this is strictly better than putting the offer there somewhat it's still not quite i was going to ask you about that because you tweeted something very interesting the other day um where you said uh there's options i don't i can't remember the strike price actually but uh what's on 72k 72k 72. 72k yeah you said if you're going to if you if you plan on i mean a lot of people have have this kind of like

plan that they stick to where uh if there's a big run-up in btc they they sell some btc at different prices right and they yeah yeah was themselves to stick to that yeah and you said if you if you are going to sell it near 72k anyway then why not why not sell these these calls right so is that um so is that is that strictly better than not doing it if you have like a plan where you definitely want to sell there or am i missing something the main difference is that um if the price gaps through your limit price what you would have done so so selling the call is better strictly because you're

getting the time value of that option that's being paid to you by the call buyer right so your money you're getting money you're getting money every day that the price doesn't get there by expiry and so if you already have those btc and you're willing and you would have sold there anyway then you're adding on that that premium value to your net worth so so that's free money in the sense that you would have sold there anyway the the obvious question will be like why are you the type of person who sells at some price anyways why you know why why are you that type of person right but that's getting into risk aversion and that's getting into you know lots of other kind of more very

tricky concepts yeah your decision should be a function of the context at the time not because like you decided you know when you were lying in bed it's three years ago that that was the price you wanted to sell out well i mean empirically people who right uh assuming you make good decisions i guess yeah so that's why you know the efficient markets people they kind of fundamentally don't really get market sometimes right because you know the average joe he does not wake up and think about what is optimal he just tries to live his life a little bit better than the day before right so in that context selling a call on bdc uh he already owns may be a great strategy because if it doesn't get there maybe he uses that premium to buy more

bdc and then he sells more calls each time and if it gets 72k he's not fussed about it because maybe he has some cold storage as well and he's okay letting these bdc go to some fun that bought these calls from him right so it's all about you know risk aversion and it's all about you know what is the purpose of wealth to you right uh options kind of crystallizes that nicely because um i do think though like the log wealth linear wealth talks like it really comes into play with these wings on bbc call it's like the does anyone need more money when bdc is at 72k some people don't need more money they have enough so selling a 72k call it makes sense for

them because they don't need more money after 72k they can buy you know their reasonably sized house and they can move on so yeah i think i think because then you have the participants who are um you know they're just pure uh i'm not quite sure what the perfect way to phrase it is but they're like pure ev maximizing so the whatever that their wealth is at 72 btc is irrelevant to them what's relevant is have i made like maximum returns on whatever's happened in the last x time period up till now all right now uh and then as a slightly separate thing on the on the kind of those wingy options uh you know like

there's been some pretty large flows going through over the last month in some of the like uh 32 to 40k strikes for example um we you know like we'll trade a lot of those wingy options uh both top side and downside but we don't with the no real view on uh the spot i'm like you know if spot is going to be in the money on that option at that specific time because those those wingy options give you like a lot of grunt in certain uh certain events so there's a lot of there's come some quite nice kind of

strategies that carry fairly well that have a lot of behind them that you can kind of get into by by dealing in those wingy options because they're so convex to be long josh you said something earlier that really fascinated me um and i want to want to uh kind of move into that direction so there are people who who trade only sport or futures radio options and then so they trade always the same exact product right but then another way to look at trading and i'm sure this is how you actually look at it and longer term investing is that you should first think about kind of the exact kind of financial exposure that you want based on kind of your general beliefs

about the market and then you create a mix of products to create that bet in a sort of capital efficient way right yeah in general so i mean if you put that into like options terms of like i want to be long and i think the market's going up over the course of the next month uh you know there are a bunch of different ways not infinite but there's a lot there's a lot of ways you could express that view depending on how many options you want to trade etc so i mean you could say um i'm going to be long a bunch of spot and i'm going to buy a put and that put is a hedge and it protects me and i can be along the spot and not have to worry about taking profit or not having to worry about you know

getting wicked out like i've got protection for a month or whatever so that's like a pretty simple way uh you know then you have the oh i'm gonna buy a call and i'm just gonna spend the premium on my call and if it pays out then you know that's great then if you then you know i guess i could give a bit more context of the actual actual specifics of the options so you might do that if you are like a professional you might do that put because you think that voles on the downside are really cheap um and the voles on the top side are quite expensive uh but you want to be long and you're kind of bearish of all like you think we're just going to grind higher you think the skill is expensive so maybe you just want to be like shorts

and puts and you think well's high so you want to be shorts and puts and you know maybe you want to be a long spot and structure it such that you know you can deal with whatever happens on the downside right it's not like you're going to sit on it or the calls you might think oh you know evolves generally cheap these calls pay out pretty well um i don't want to get wicked out of my spot position uh this the different the the calls are cheap relative to the relative to the puts and the balls are fairly priced okay i'll buy some calls and i'll sit on them or then you might say okay well i don't want to be sure to naked option to the downside because if i'm you know i might not want to run the spot position all the time and i don't

want unlimited losses etc but i don't want to spend all the premium to buy a call and i think vols are like fair to maybe like mildly expensive but they're like broadly whatever um and the the difference between calls and puts maybe calls are a bit expensive um but it's not crazy so i'll do a call spread and i'll buy you know like a 10k call and sell a 15k call and just sit on it and see what happens or you could then say oh you know what i actually think involves because that will give you basically a long delta exposure where you pay less decay but you have a limited upside and limited loss

because you sell the call right so the asymmetry of that is a lot of that asymmetry is determined by what is that volt that you're selling that call at um at least relative to the value you're buying the core so but then you might say well actually i think voles are expensive here and i think that skew is too exp to well crypto flip it around so i think this the sku is too cheap i calls it too expensive especially the wingier calls so maybe i want to actually be long spot well i want to be long delta rather but i want to be short vol um so to be sure well i have to buy a 10k call and i have to sell

two 15k calls so i now technically have unlimited loss to the upside but the break-even on that trade is obviously going to be very good because by the time you get to a short strike you've already made five thousand dollars per lot so your break even is you know well above that strike um you know you can do those ratios they call them in in any ratio um or you know you could say well i think that skew is is uh really cheap really um encrypt that would be expensive i think puts a way too expensive relative to calls and i think i'm very bullish and the market's just not going lower

and i just want leverage to be long so you might do a risk reversal you might sell a court sell put and buy a call and just leave it so that there you've got the same like delta view but like every trade has like different to very different grapes on it and i mean you can get a you can get more more complicated than that and if you're trading your book in a fashion that is even like remotely delta neutral then to get something optimal uh becomes more complicated again what do you think about the way you roll over actually like how do you handle the quarterly and the monthly expires

in terms of your your thinking of it it's kind of painful um especially when you get like outrageous deltas at expiry uh i think well two things we do one thing we do is we as we kind of come into the expiry where we can we try to hedge our options with options so we'll try to kind of sell some options or buy some options back such that at expiry our like life will be easier as long as it like doesn't give away too much money so we do a bit of that to help us um i think like from a trading standpoint otherwise you just kind of grit your teeth and like do the best you can uh from a market market standpoint i

think it i think it has an impact i think even sometimes the weeklies have an impact to be honest like if i'm not even i mean obviously there's if there's a huge amount of oi or a huge amount of strikes like that makes a difference but i'm not convinced that you even need necessarily like to have a huge amount of total oi i think if you've got kind of the right players with the right strikes in the right size even if the total oi is not that big like they can still have like quite a large impact on the spot marker right like you might just have a random friday where a delta neutral guy has got you know

i don't know like 3 000 x of like a strike that's in the money and he hasn't like delta hedge it and nothing's happening and there's not like this huge expiry spell like one dude has a massive ticket to do so i think like i think it's a bit random i think it's hard to it's hard to like uh create a strategy that's like high alpha around it aside from like you know sometimes it'll matter and sometimes it won't and just kind of assume that it has some impact it's hard to benchmark that's probably not very useful though what do you think yeah i mean it's tricky for us i mean we generally use options for hedging as well as for uh speculation when we think it's good value so it's it's definitely painful to manage the expiries

uh because what because we'll just buy we'll usually just buy spot if we need to replicate in the t-wop um window uh to get the deltas back uh rolling uh i think i think it's like we we try to match off with the flow that got us in the position in the first place so i feel like you know doing it then is the ideal time right when you get the big software coming back in um yeah that's true i guess if both people decide they want to fix it up then um that works like i mean we have had instances because we run multiple different books right like so we run um what what do we have now one maybe like seven therapy books but

like for various reasons i mean and we replicate positions across denominations obviously but you get differences um and we have kind of two volt strats that we run so sometimes they'll have different risk so there are times where like we one book might have like 200 bgc to sell and the other book might have like you know 100 bgc to buy so in those instances we can just like match each other off um but if that's not the case then you just yeah you just kind of got to chip it in right it can be a bit of a pain though like if you've got a large delta well if so if you've got a large change in your delta over expire and you want to keep that delta i mean

you can end up right saying say it's like you're long if the market's getting belted over that like half an hour 45 minute window and you're having to run like you know 30 to 50 longer than you would like for expiry purposes like it can be a real pain i honestly i think i think the most crazy thing in the market these days is what i alluded to on that call which is like every friday after expiry or even slightly before like voles just get destroyed like you know it's pretty common for for front end to be down like 10 to 20 volts between like five o'clock saturday at five o'clock friday night and like 10 a.m saturday morning right because they just come in yeah they just yeah they come in and

they just like basically destroy it um so like there's stuff like that where it's kind of like sometimes i just sit there shaking my head just being like you know what are you doing but i get they just don't want any decay over the weekend i think we we touched on a lot of different um of the so-called greeks and um i do i do want to get into um kind of the basics of how to price options and and what actually uh those greeks and what they mean and i mean this in podcast format this can't really replace people sitting down and actually like reading uh through like a proper explainer and maybe like playing around with it but um in

your own in your own words like how would you how do you explain how how to price an option what those different factors are uh yeah i mean so i think if you're trying to price an option all you're trying to do is figure out is the value of this option um fair or not who is the value of it to if it's not fair is it too cheap or is it too expensive and you can take your approaches to that you can take the market making approach or you can take the um the kind of thought i should call it the relative value approach slash market making approach or you can take the kind of like directional pure buy side approach um so i mean in crypto lab most people use a standard kind of black scholes um pricer

which has a few assumptions i won't go into too much detail but like you can google it on wikipedia it's like fairly standard uh in um traditional markets i'd say you people use diff there's more complex models being used now like fx practitioners often use like well mainly stochastic volatility models are used but uh there's a few there's a few different models um but for crypto purposes most people use black shells still so i mean if you're in one sense if you're a price taker you almost don't need to price the option per say because it's pretty simple like you think you can make that you know if

option cost x you think you can get far enough in the money that you're like x plus something um then you should buy it right like you don't really care if it's worth 70 volts or 72 volts because you think it's going to go 10x so like bowling sensitive to some extent um and you know there was there was like there is that thing that like if you want to trade an option and like the market makers are showing you x and why is there like bid offer on their two-way price you you pretty much have a choice where it's like well i can trade it or not trade it so it's like maybe am i slightly overpaying for an option like maybe but like do i think i

still have an edge unit like yes okay well i'll just trade it that's the like it is what it is i'm just gonna try yeah like it is what it is you know um if i if that's what the market price is like do i think it's expensive or cheap buy some small amount then like so be it right so i mean i have to and i've done like a fair chunk of that where it's like well yeah this option is probably like two of those expensive but like you know i'm gonna hold it and like it's just a like maybe it's just a punch in my pa for example well you know maybe it's slightly expensive but i think it's going to go from 6k to 20k so i don't really care um if you want to trade you know like the vols and like properly like show for

example what a market maker will do like a market maker will have their models that will be spitting out what they think the fair voles are and then they will have basically it spits out what they call like a theo which is a theoretical vol which is what their volume is basically and then they will put their bid offer around their theoretical vole such that they have you know an amount of full edge a spread that they're happy with and then they will just auto code that all day because according to their according to them the prices that they use um you know every time someone crosses that spread they're paying too much or two or too little and when you have they'll have a book of x sum the number of strikes 100 strikes

across like 10 tenors and it all kind of you know they net it out and that's how they make their uh that's how they make their likes spread um or that they're all so that's the kind of classic market maker or you have the relative value firm where you know they'll look at they'll look at all the voles as well like a market maker but they may not necessarily have like a theoretical vole for every single strike on every um serial because like that's just overkill right instead they might have like a firm like us for example might have you know a bunch of analytics um and we might have our own kind of discretionary views on smiles and

skus and flies and curves and baseballs and you know all kind of all kinds of stuff um and so we'll you know our analytic we'll run our analytics or whatever and it might say okay well um this this part of this skew curve is like cheap or like this part of the smile is expensive or whatever and we'll have our views of well i think the curve's too flat i think the curve's too steep and you know once we kind of get to our like i guess bit more um kind of quantitatively driven but more holistic view um on where the value is then we'll like dive you know in in more depth to that specific part of the market so then we'll go and we'll you know have a

look at all the specific options which one's going to decay the best which one's the cheapest you know if x happens which one will give you the most convexity what's the best thing to sell against that so instead of or buy against it so instead of um you know instead of trying to model a theoretical value and build a two-way price on every option we'll basically come to a view of like what we want our books to look like what is the view and then we'll just deep dive into like those specific options um and we'll have more of a general view on that the other options right uh so that's the kind of the third way to do it and within that there are a bunch of you know there are a bunch of like different

volatility techniques you can use depending on how you want to trade it um and you know there's there's a few like characteristics i guess that that i find helpful um about like how you if you want to be like long convexity like think of like uh it's probably a small athlete but i think it's okay but i you want to like buy options that when you want to sell them will be hard to buy so everyone else wants to buy them and you want to sell options that when you want to buy them back will be easy to buy and everyone will want to sell them so that

if you have that in the back of your head if you're trading like a kind of book with multiple options and legs in it then you tend to end up in a scenario where if this hits the fan you're you know have you have some uh you've generally done okay it's a very good answer i think it's very illuminating if you think about also like a lot of participants they get overwhelmed by options markets because they think it's all about the model they think it's all about you need to have the most cutting edge model you need to have the biggest eggheads in your firm right and actually like for practitioners they realize that you know for for a small subset of participants what they are trying to do is classical market making they're

trying to match off the you know the most expensive the richest part of the curve with the cheapest part of the curve to put on those positions such that you know their greeks are manageable their risks are managed and then they're capturing you know the difference between what people are willing to pay for the most expensive stuff versus the cheapest but then outside of those players there's a whole wide spectrum of discretionary players and it really does make it very important to have a view as well on how the markets will evolve like josh said you know what kind of options will be very hard to buy if the market moves this way what options will be very hard to will be very easy to sell and these kind of things so i think like you know if you look at in the

traditional markets right there is a lot of trades where the where the balls become irrelevant if you have true alpha asymmetric alpha on the delta right like let's say dollar c and h calls when the price is near seven and you're a pboc and you know you can defend seven then the vols are relevant the balls are relevant you even two ball is too high like you know and and similarly like euro swiss puts before the swiss national bank right like you can pay any like any ball you want and actually you know so so there's even like philosophical debates about like can you actually price a model using a ball model or is it all mental right so so once you realize that then

you realize the model is irrelevant if you're if you're if you're a true uh big player in the market or you're a big speculator in the market and you feel that bitcoin is a is a is an exponential koshi process then all calls are mispriced right because at any point bitcoin can go up 100x or 50x or 10x within the course of a few days so from that point of view you know putting a model on it you know you you may say that like like any call spread you know you want to buy the wing because because because your model your your mental model is different from an options practitioner's model right yeah i mean you could have an example of that like an example of something now might

be uh okay i can sell everyone's i'm i can sell uh you know 21 22 23k calls at like somewhere between like say 65 and 80 volts and i can earn that premium that's cool um but what happens to voles if btc goes to 21k like those even accounting for what you would call like this this the role or slide like on the smile which would be as your option delta changes your vols will change but even accounting for those factors which we don't have to go into

like i'm pretty confident that if btc went from 19.4 wherever it is now and at the end of this podcast it was at 22k like those vols would be you know you'd be lucky no boy you wouldn't be at a for a start you wouldn't be able to buy any um you know but but if you were managed student to buy something like you're probably paying well in excess of 90 volts so like that's a vole that looks you know obviously people are happy to sell it they're happy to sell it now because like we haven't gone above 20k and whatever but that's not necessarily i would say that's a very bad goal to be sure because like the scenario where the market goes higher like you're

probably in a disgusting position um and in the market the scenario where the market goes lower it's probably going to be relatively sharp sell-off so like initially vols may even be supported on that and certainly if you're running a delta hedge book like that roll down on those on the voles will hurt you because like your 30 delta option will roll to a 10 delta option and the vol you have on that option even accounting for like lower vega will um go from you know 60 to 80. so like i think that's like not a very good vault to sell for example that's like seems to those types of options seem like obvious buyers really irrespective of like what your actual spot view is

um but i mean i personally think like the base files are generally on the low side here anyway so so something that maybe that what's interesting to me is kind of what what the original answer didn't say are we kind of interested in do you think it's not necessary to to understand what the different greeks are and how they how they work in order to be an options taker uh no i think if you just care about if you just want to like punt a spot view via an option then like as long as you can compute like what your payout is and like what your losses like you can be profitable like there are definitely crypto traders in the in the market who are who are you know not professional traders but very good delta

traders and they make you know a lot of money trading options um but i mean i would say most of them know like all the basic greeks but like that's not their money isn't necessarily coming from like greek analysis it's coming because they've put that they've found some like cheap or like asymmetrically payoff um profile options that you know support us are generally correct spot view so i mean that's definitely you could definitely do that that's definitely true that's definitely true and and i actually i would even go further than that and i would say like oh like a a little bit of knowledge is a dangerous thing because because i was speaking a light about this the other day but like when he started to realize that

like you know he's paying these ball spreads whatever he got really into trying to get the best price possible and trying to buy in the middle of all but by definition you can't do that anyway you have to just ask all the market makers and then buy the best offer right because because because as a taker that's priced in and part of that price in is that makers will know sometimes you're sharp and the market will go in your direction right so so he said like you know because of that he ended up missing out on like half his size like right before the big c pump uh in 2019 where you know it went from like 7k 7.2 to 11 11k in like 24 hours right so you know it's stuff like that where you know how much greeks do you really

need to know to trade options i honestly don't like think it's very much at all um i think knowing knowing too much and then thinking about it all the time actually will make you a lot worse because you won't yeah there's some leveling as well right there's a lot of leveling where you want to get the absolute best possible fill at the best possible times you want to start being a marketer yourself but you start to lose the whole point of trading an option in the first place as a speculator which is that you're exploiting the curve because like you think about buying stocks right i i try to get this analogy when you buy stocks you're also not at like analyzing like every single exchange making sure you get the absolute best tca make sure you get the absolute best possible price because the

because the size of your gain if you're right is so much bigger than any optimization you can do on the microstructure that it doesn't it doesn't matter as much right and i think the same applies in in options as well where like you think about the put sellers right that have come into the market and you know if they have hundreds of millions of fiat behind any put that they can sell is free money because they can buy because because they'll buy the spot themselves right like sailor if he knows he's gonna buy if he knows he's gonna buy half a billion of spot and he can sell a one week put that that to him is actually free money yeah literally money and and imagine him thinking about volatility right like

it would be mentally ill for him to think that way and and because of the flows in crypto there are a lot of these times where people do have this kind of value so a lot of times when the skew moves a certain way or like the you know the curve moves a certain way it's like is it value or is it a trap is it you know these kind of things are always in the in the mind so it's often sticky like it's persistent when it moves even if it looks wrong there's generally not for no reason and you know in a macro world there's so many smart people with lots of money sitting around like trying to up out every little thing that if you see something that's a bit wrong you can put it on it's pretty much done like it's it's all you can take it off the

next day crypto you might have to sit on like some sort of rv position for months like as it all goes through the market and that is just both painful and like not a very good use of your var i think the other point you made about a little bit of knowledge can be a dangerous thing is a super important point actually because in a sense you know like you start training options you know you learn some stuff about options you become you know at the point where you start to trade evolves or whatever but like it's pretty unlikely that you know anyone self-taught and like just a lot of people generally speaking are going to have an edge in that like relative value

kind of highly technical playing field you know unless they have the experience of learning from someone who's done it or having done it in like a professional environment like your edge is just very unlikely to be large in that sense like i think the key is really just to say well what a what type of options trading strategy do i want to employ and like b is it realistic that i can employ this strategy and like have some positive ev um you know so like if you're kind of a a an average or normal trader the answer that question is likely going to be uh okay well the strategy that i have the most ev in that i can employ

without making gratuitous errors by accident or like leveling myself you know or doing something where i think i know what i'm doing but i make a mistake that strategy is likely going to be some sort of directional you know options trading strategy where you do call you buy calls you buy puts you buy put spreads you buy call spreads you buy straddles you buy strangles or you sell them and you know you just say it you just look at the payoffs you look at like real maybe realize first implied vol um and the and just like a charter vol and like does it look low does it look high kind of thing and then see where realized is and you look at the the difference between the balls and the call and the

puts to see where which is more expensive you just take those pieces of information basically and try and like put on a trade that has some positive returns to it right and trying to trying to go in and think about well the smile and the skew you know the the smile and the curve and what's going to happen to the curve if this vault moves here and like you know what's going to what's this vanna going to do and like what about my volleyball and like you know all this kind of other stuff like what's my um you know like the greek that represents my skew like what delta do i need to run to hedge that skew out like you're just gonna end up in a disaster yeah my personal opinion okay so i have one

question that was a bit of a rant sorry who knows very interesting uh i want to find a question um which is we all love defy right the decentralized finance on ethereum and uh there are a couple decentralized options protocols now uh hedging uh open i don't know if they're any more actually but i think there are a couple being this i've heard of one that's being built but i don't wanna there's two that i know of that are kind of currently developing so well yeah they're sorry there's another one um pod pods finance is another one and then there's a couple more but i don't think i should say what they are yet but there are a

few out there definitely hedge you can open are the like dominant dominant ones yeah for sure so what are the what are the trade-offs um between decentralized options platform and the current i mean it's you can't even say market leader right there a bit owns like overnight yeah it is the market um although i see him see him he is kind of it's kind of growing i mean i think one of the major and i'm a big fan of jerry bit um you know one of the major advantages that derby have over every one bit c5 or d5 is portfolio margining um you know it's very hard to trade options in a professional capacity without portfolio margining even if you

want to do uh basically it means that you don't have to put up the entirety of the um the sold option so you know when you buy a call you put up the entire premium um when you if you sell it you you get like a margin credit um because you're not you're not outright short a call in a call spread like your short call is matched off with your long call basically just means you get more and you basically portfolio margin at its core allows you to sell um options with like good collateral usage basically um so you don't have to put the full notional down for every option you know you um sell so without that

it's very very inefficient to run any sort of portfolio that has any short options in it basically and i don't think anyone else is doing a pm so that's a huge advantage for them i think it's not really easy to do in d52 unless you can know where you're going to source your liquidation from because the only the only way you let someone sell a call let's say for more bdc than they put up is if you know how to liquidate them when btc goes to the moon right because they won't have the money to pay out so they need to stop their position now uh that that will have unlimited loss right by definition yeah exactly and it can go unlimited overnight right so as we've seen plenty of times so i think that that is a struggle

in and i i think kind of i mean that that was our thesis when we invested in derivative which is that clearing is a network effect in in options where the more people come to darabid and trade on portfolio margin the more people want to as well because that's the best most capital efficient way for you to express your options views and so i think def is going to have a lot of problems with that unless they can also source let's say the perpetual swat you kind of need a perpetual swat market primitive yeah yeah you haven't right yeah be able to hedge off that option because otherwise anything else you can come up with would just be mentally like it would it would make no sense how because because you have to liquidate an actual option and then you need to have someone

sitting around to to to have capital ready to trade that it doesn't it it's strictly worse than everything in c5 by a lot if you do that i think hedgic um is interesting and and we do participate in hedging in the sense that uh you are backing you put up capital and then you are you are saying whoever comes they'll you know buy options from me and i'm selling you know in the in this indiscriminate way but i think the nice thing about that is uh you you can you get kind of like a synthetics kind of a a mentality too where like people then come and then they they they feel the need to trade on it

without necessarily checking the best price so they're not that price sensitive they just like the idea of using a hedge like using hedgic while also being a part of it uh while also staking in it you kind of get this kind of you know not not very price sensitive action and not very capital sensitive action uh which i think is is very good for for hedgic and and for any product which manages to achieve that so i think yeah i mean some people do value i mean thereby now has ksc i think studying exactly generally that's maybe the the big advantage yeah the other thing i think to us this point was um that when it comes time to liquidate that person on the short option

if it's like in extreme circumstance i mean even on derby when the stuff really gets wild yeah even on there it's nuts you can't trade right like there's there's either like nothing on the screen or it's too the volumes are too small like it's just it's it's and it's not that it's unusable it's definitely the wrong word but like you know if the market is just gap 20 like no one's going to stick like a two-way um on the screen of like 500 btc and what if you've got like a thousand btc notion or like call that you're just getting liquidated on right like there is no vole there's no vol hedge in that scene in that scenario they just have to hedge basically the gamma and like that it is what it is so yeah i think you're

right that um and i hadn't thought about this until right now but i think you're right that a big um a big thing for the d5 options protocols will be having liquid perp markets alongside them yeah like in early 2018 i remember discussing bitcoin options with uh with cumberland and a couple other firms and they were adamant that you would never see a liquid bitcoin options market because bitcoin itself would be so volatile that would be impossible to hedge the the the gap moves and so thinking like where it's come now it's already quite it's already quite impressive that you even have options in in c5 and then you know and i think a large part of that has been due to the portfolio margining people

more and more participants coming and then trusting it and then cme coming out and you know less capital sensitive people coming in and also selling calls you see it's kind of close uh and like if you think about like in march april 2019 uh i think on the bitcoin move from 3.8 to 5.5 and then 7k on that snap move i think more than half the market makers got wiped on that move or something like that i can't remember the exact numbers yeah i remember it was pretty mental you know because they had calendar spreads on you know they had diagonals they had a lot of like ratios that you know all the assumptions are wrong because the price just doubles right yeah yeah yeah and and so when i think about d5

options being able to handle massive amounts of liquidations i think it's i think i think perps d fight needs to handle perps very well first uh the only reason why derebit was able to do options in a huge way was because perps were already very liquid at by that point um i think i think it that kind of has to come first for you to get the proper scale that you need for options in d5 yeah that makes sense i mean i do think over time i do think over time that like you know d5 options will grow and like i am bullish that as a as an asset ambush both c5 and d5 options i think they cater for different players and this room kind of both um so it's definitely not like yeah i'm not like

not bearish on it or anything like that i think uh there are you know there's like short-term challenges that everyone would acknowledge around like liquidity and um or all that kind of stuff but like they're this they're not insurmountable by any stretch of the imagination so would you say the two watershed moments for d5 or options in d5 would be a liquid perps or very liquid prop market in d5 and doesn't have to be the same protocol right they can hook into each other way better than the centralized exchanges can and second solving portfolio margin yes they would definitely be the two things for me and i think those things you know obviously you need

liquidity right but like it's a circular thing where like you know to get liquidity you need to have these other things and to have the other things you already want to have liquidity because they're like you know hard or whatever to implement but um eventually that you know that gets cracked i mean cfi also has you know there are other there are you know new exchanges like bit and etc coming up in c5 so there's like competition which is always a good thing and um you have those firms that are trying to help the ecosystem as well and see if i write like um for block trading you have paradigm which you know is is doing well uh for bilateral stuff x margins working on it so like there are um there are still kind of unsolved

issues in the cfl options as well but you know people are kind of people are like hammering away at that stuff and d5 options have only been around for like what a couple months like a few months max like it's it's very early to expect it to be solved right like you know right now i think is is not realistic but um yeah i mean we we've traded it on um open we've done a little bit on hedgic as well um most of our volumes are on the c5 exchanges for the reasons that we've kind of discussed like efficient use of capital liquidity um you know the style of trading that we do et cetera et cetera but like that's certainly uh the d5 stuff is certainly

something that we're interested in and you know helping to grow the uh of the options pi both c5 and d5 for everyone yeah i think that's uh that's a great way to end this um thank you so much for your time both of you josh and sue um just do you want to say where people can find you yeah sure um you can get us on our twitter account at ortho trading o r t h o t r a d i n we have a website as well but probably the most active which is just that is orthogonal.trading is our website but yeah probably twitter is where we're

most active uh most active one in the general sense and people who know me can find me you know wandering around the crypto scenes yeah it was a uh illuminating conversation for me learned a lot thank you thanks guys appreciate it yeah thanks for being on