Concepts & Definitions

"An investment in knowledge pays the best interest." — Benjamin Franklin

Before we begin, it's important that you familiarize yourself with all the basic terminology associated with using OptSwap. This way, you can better understand the rest of the documentation and communicate well with your peers.

We recommend bookmarking this page and referring back to it as needed in the future until it all becomes second nature to you.

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⛓ Blockchain

A Blockchain is a distributed database network which stores data in a growing list of records, called blocks, that are securely linked together using cryptography. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data.

As each block contains information about the previous block, they form a chain or "blockchain," with each additional block reinforcing the ones before it. Therefore, blockchains are highly resistant to modification of their historical data.

Once finalized, the transactions in any given block cannot be altered retroactively without invalidating all subsequent blocks. Invalid blocks are automatically rejected by network miners or validators and a bad actor may bear an economic cost associated with their actions.

🟠 Cryptocurrency 🔷

A Cryptocurrency, or Crypto Token, or Crypto Assset, is a digital asset designed either as a store of value, medium of exchange or utility token through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it.

The first fully decentralized cryptocurrency was Bitcoin, which first released as open-source software in 2009. Another example is Ethereum, released in 2015, which has smart contract functionality that allows decentralized applications to be run on its blockchain.

🏛 Decentralized Autonomous Organization (DAO)

A Decentralized Autonomous Organization (DAO) is an organization constructed by rules encoded as a smart contract that is transparent and governed by the organizations members. A DAOs financial transaction records and program rules are maintained on a blockchain. It differs from traditional corporations in the sense that its existence is completely on-chain, open and governed by immutable smart contracts and rules.

💹 Decentralized Finance (DeFi)

Decentralized Finance (DeFi) is the philosophy and practice of recreating, reinventing or extending Traditional Finance (TradFi) concepts, instruments and transactions on the blockchain using smart contracts without the need for any intermediaries or third parties. DeFi protocols utilize on-chain smart contracts to automate financial tasks and to enforce financial rules & obligations.

Examples of important DeFi applications include cash/spot exchanges (Uniswap/Curve), perps/margin exchanges (dYdX/GMX), borrowing & lending markets (Aave/Compound), cross-chain bridges & messaging (Wrapped Bitcoin/Axelar), collateralized debt positions (MakerDAO), synthetic assets (Synthetix), on-chain oracles (Chainlink/Tellor) and prediction markets (Pancakeswap/Polymarket), amongst many others.

DeFi is a nascent industry and is evolving very fast. It holds huge potential reducing tranasction costs and improving market efficiencies through smart contracts & automation. However, there are many known and unknown risks associated with DeFi and this is an ongoing field of research.

📝 Options

An Option is a financial instrument or derivative contract between two parties which grants the owner (the buyer or holder) the right, but not the obligation, to buy or sell an underlying asset at a specified strike price on or before a specified date.

Options are themselves a form of asset and have a valuation that depends upon a complex relationship between the option type & style, underlying asset value, time remaining until expiration, market volatility, benchmark interest rates and expected dividend yield, if any.

📈 Call Option

A Call Option grants the owner (the buyer or holder) the right, but not the obligation, to buy an underlying asset at a specified strike price on or before a specified date. The Call Option Writer (seller) is obliged to sell the underlying asset to the option owner on or before the specified date if the price of the underlying asset is above the strike price.

📉 Put Option

A Put Option grants the owner (the buyer or holder) the right, but not the obligation, to sell an underlying asset at a specified strike price on or before a specified date. The Put Option Writer (seller) is obliged to buy the underlying asset from the option owner on or before the specified date if the price of the underlying asset is below the strike price.

💰 Moneyness

The Moneyness of an option refers to whether the price (current market price for unexpired options or the settlement price for expired options) of the underlying asset is above or below the option contracts strike price.

A call option is said to be "In-The-Money" (ITM) if the price of the underlying asset is above the strike price, or "Out-of-The-Money" (OTM) if the price of the underlying asset is below the strike price.

A put option is "In-The-Money" if the price of the underlying asset is below the strike price; or "Out-of-The-Money" if the price of the underying asset is above the strike price.

If the price of the underlying asset and strike price are exactly the same, the call/put option is said to be "At-The-Money" (ATM).

🇪🇺 European & 🇺🇸 American Style Options

A European style option limits settlement only to its expiration date. A buyer would not be able to exercise the option early or take delivery of or sell the underlying asset. Instead, the call or put action will only take place on the date of expiration of the option.

An American style option, on the other hand, can be exercised at any time up to and including the date of expiration providing more flexibility to the buyer, but at a slightly higher cost. The names of these two styles of options should not be confused with the geographic location as the name only signifies the right of execution.

🔀 Option Spreads

An Option Spread involves the simultaneous buying and selling of options of the same type (i. e. either puts or calls) and expiry, but at different strike prices. These are also known as Vertical Spreads. The term "vertical" comes from the position of the strike prices which are one above or below another.

This is in contrast to a "horizontal", or Calendar Spread, which is the simultaneous purchase and sale of the same option type with the same strike price, but with different expiration dates.

Spreads may be Net Debit or Net Credit. Vertical and calendar spreads may also be combined for esoteric multi-legged strategies. Examples of spreads include Bull Call Spreads, Bear Put Spreads and Iron Condors.

🧮 Option Chain

An Option Chain, also known as an option matrix, is a listing of all available options contracts for a given underlying asset. It shows all listed options contracts, strike prices, volume and pricing information for a single underlying asset for a given expiration time. The chain will typically be categorized by expiration date and segmented by calls vs. puts.

👑 Underlying Asset

An Underlying Asset is the actual financial asset upon which an options price is based. Underlying assets give options their value. For example, an option on Bitcoin gives the holder the right to buy or sell Bitcoin at the strike price up until expiration. The underlying asset for this option is the cryptocurrency Bitcoin.

💵 Cash Token

The Cash Token is the cryptocurrency in which the option contracts Premium is paid. For example, an option on Bitcoin may be quoted at a Premium of $100 in USD Coin (USDC). The cash token for this option is the stablecoin USDC. Options may optionally also be settled in the cash token after expiration.

The Strike Prices for the options and Strike Price Ranges for spreads are also always denominated in the cash token.

🔢 Strike Price

The Strike Price is a pre-agreed price level at which the underlying asset can be bought or sold when the option is exercised on or before expiration. The strike price may also called the exercise price.

For call options, the strike price is where the underlying asset can be bought by the option holder; for put options, the strike price is the price at which the underlying asset can be sold.

Option spreads are represented by a Strike Price Range of two (2) strike prices.

📆 Expiration Date & Time

The Expiration Date & Time, also called the Expiry Date, is the last day that the option contract is valid. Trading or exercising the option must be within this given period, which is on or before the expiration date & time depending on the style of the option.

Once the option passes the expiration date & time, the contract can no longer be traded. An expired option should be exercised by the buyer, or settled for cash, if it is In-The-Money. The seller recovers any excess or leftover margin after expiry.

🔁 Decentralized Exchange (DEX)

Decentralized Exchanges are an alternative to centralized exchanges. They cut out the middle man, generating a "trustless" (or "trust-free") environment. These types of exchanges function as peer-to-peer exchanges. Assets are never held by a centralized escrow service, and transactions are done entirely based on smart contracts and atomic swaps in a "non-custodial" manner.

⚙️ Trustless

Trustless means that you don't have to trust any third party, person, or intermediary that could operate between you and your cryptocurrency transactions or holdings. Trustless systems work and achieve consensus mainly through the code, asymmetric cryptography, and protocols on the blockchain network itself. The trustless environments that blockchains have created enable the peer-to-peer (P2P) sending and receiving of transactions, smart contract agreements, and other complex interactions which cannot operate without it.

🗄 Non-Custodial

Non-Custodial means that no third party, person or intermediary holds, or has access to, or can manipulate your cryptocurrency holdings, orders or positions. All the crypto assets are held on the blockchain and are controlled directly by the smart contracts which are governed by software code. Only the rightful owners can trade, settle and withdraw their own funds.

📖 Order Book

An Order Book is an electronic list of buy and sell orders for a specific option organized by price levels. The order book lists the number of lots/contracts being bid on or offered at each price point, a. k. a. the market depth or market quotes. The order book helps traders make business decisions and improves market transparency because they provide actionable trading information.

🧾 Limit Order

A Limit Order is an instruction to buy or sell a specific option contract at no more or less than a particular price point. This gives the trader control over the price at which the trade is executed; however, the order may never be executed or filled. Limit orders are used when the trader wishes to control price rather than certainty of execution.

📚 Batch Order

A Batch Order constitutes two or more limit orders which are combined together and sent to the decentralized exchange as a single blockchain transaction. The batch order may be instructed to be executed or filled partially or fully. This allows traders to be guaranteed execution of all limit orders within the batch, reduce slippage and save on transaction time and costs.

🔣 Fill Types

The decentralized exchange may not be able to completely execute or fill a limit order at a particular price and/or at a given point in time due to the unavailability of counterparties. In such cases, the order is said to be "unfilled" or "partially filled." Traders have the ability to specify whether they want to allow their orders to be partially filled or not by choosing the Fill Type.

The "Limit" fill type allows orders to remain unfilled or partially filled and sit on the order books as a maker order. The "All-or-None" fill type enforces that all the orders within a batch are either "completely filled" or "fully reverted" as though the batch order was never sent. This allows traders to be guaranteed execution of all limit orders within the batch which is highly relevant and useful for advanced multi-legged strategies.

🤖 Automated Market Maker (AMM)

An Automated Market Maker is a smart contract, or computer program, that allows for matching buy and sell orders automatically, based on preset criteria, without the need for any intermediary. There are many different types of AMMs with varying implementations.

OptSwaps AMM is highly specialized and focused on options and option spreads. It is designed to work with the DEXs on-chain order book in a seamless manner. This is achieved by traders instructing the AMM to process and execute their managed orders only if a counterparty matching specific criteria is also available to trade against; and recalculating the premiums and execution risk criteria on-demand using real-time market data.

↕️ Managed Order

A Managed Order is a special type of options order containing instructions for the AMM to execute or fill it only if the specified Risk Criteria are met. The risk criteria are specified as ranges of strike prices, expiries, premiums, implied volatilities and options greeks for the options contracts that the trader wants to buy or sell.

Instead of specifying a specific price point to buy or sell at (which can vary from one second to another based on market conditions) the trader defines the risk criteria in advance and the AMM buys or sells the options on behalf of the trader, if and only if a counterparty also matching the specified risk criteria is available to trade against at that given point in time.

📦 Lot Size & Lots

The Lot Size, or Contract Size, is the number of units of the underlying asset that a single option contract controls. For example, the typical lot size for stocks is one hundred (100) shares per option contract. However, the lot size for different types of options or underlying assets may vary and can be any number (within practical limits). The lot size is fixed for any option contract and does not change during the lifetime of the option.

Lots, or Number of Contracts, is the number of options contracts that the trader wants to buy or sell. Options must be bought or sold in multiples of one (1) lot. Lots cannot be divided or traded fractionally.

💸 Option Premium

The Option Premium is the current market price of an option contract and the amount paid by the buyer of the option. It is the income received by the seller of an option contract. In-The-Money option premiums are composed of two factors: intrinsic and extrinsic value. Out-of-The-Money options premiums consist solely of extrinsic value.

The premium is always quoted in cash tokens per unit of the underlying asset. The total amount of premium to be paid, in cash tokens, by the buyer can be calculated using the formula: Total Amount = Lot Size × Lots × Option Premium

⚖️ Intrinsic Value

The Intrinsic Value of an option contract before expiration is the difference between the strike price and the current market price of the underlying asset. For an expired option contract, the intrinsic value is the difference between the strike price and settlement price (at expiration) of the underlying asset.

A call option has intrinsic value if the market/settlement price is higher than the strike price. A put option has intrinsic value if the market/settlement price is lower than the strike price.

🍃 Extrinsic Value

The Extrinsic Value of an option is the value that is assigned to an option by factors other than the intrinsic value. There are many factors which affect the extrinsic value including the time remaining until expiration, implied volatility, spot price of the underlying asset, benchmark interest rates and expected dividend yield, if any.

Extrinsic value is also sometimes called Time Value because the time remaining until expiration is one of the primary factors affecting the option premium.

📊 Implied Volatility (IV)

Implied Volatility (IV) is the markets forecast of the likelihood and amplitude of a price change in the underlying asset. It is defined as the one standard deviation (1SD) expected move in a year.

IV is used to price options contracts where high implied volatility results in options with higher premiums and vice versa. IV usually increases in bearish markets and decreases when the market is bullish, but this isn't always the case. IV helps in quantifying market sentiment and uncertainty. It is affected by the price history and future price expectations of the underlying asset.

🔋 Options Greeks

The Options Greeks are symbols assigned to the various risk characteristics or factors that the price of an options contract is subject to. The most common options greeks used are the first partial derivatives of the options pricing model:

• Delta (Δ): Measures the change of an options price when the underlying assets price changes by $1 (or one unit of the cash token). The delta value is a fractional number between -1 to +1. It is always positive for call options (0 to +1) and negative for put options (-1 to 0). When traders refer to "10 delta" options, they are actually referring to call/put options with a ±0.10 delta value. In this case, the absolute delta value is just multiplied by a factor of 10 for ease of verbal communication. The delta may also be interpreted as the approximate probability that the option will expire In-The-Money given the market conditions at that point in time.

• Gamma (Γ): Measures the change of the options delta value when the underlying assets price changes by $1 (or one unit of the cash token).

• Theta (ϴ): Measures the change of an options price after the passage of one day (24 hours) assuming no change in the underlying assets price. This accounts for the variation of the options price due to the passage of time.

• Vega (V): Measures the change of an options price when the volatility of the underlying asset increases by 1%.

• Rho (ρ): Measures the change of an options price when the benchmark interest rate increases by 1%.

Greeks are used by options traders and portfolio managers to understand how their positions will behave as time passes and prices move; and to trade or hedge their positions accordingly.

💶 Margin

The Margin is the amount of funds that the option writer (seller) has to deposit to guarantee that the option holder (buyer) can exercise the option at expiration if it is In-The-Money. The margin required may be in the form of the underlying asset (for call options) or cash tokens (for put options and option spreads).

🦺 Margin Minimums

Margin Minimum refers to the minimum amount of margin that the option writer (seller) has to deposit to cover an option spread position. For example, writing/selling a one hundred (100) point option spread will require a minimum margin of $100, or 100 units of cash tokens. Writing/selling a five hundred (500) point option spread will require a minimum margin of $500, or 500 units of cash tokens, and so on.

🌟 Margin Discounts

The option writer (seller) is eligible to avail a Margin Discount when they simultaneously take on two opposing positions in such a way that only one position is guaranteed to expire In-The-Money. Such a combination of positions is said to be "Hedged," "Non-Directional" and "Multi-Legged." The margin discount will be equal to the margin minimum of the shortest leg. Examples of non-directional multi-legged strategies which avail a margin discount are Iron Condors, Iron Butterflies and Box Spreads.

📌 Position

A Position is an option contract that is still open between a buyer and seller, i. e. it has not yet been settled or traded out or closed. When an option contract is open, the position is reflected on both the buyers and sellers accounts. The position may be closed by either the buyer or seller by trading it out in the market to another buyer or seller, or to the original counterparty.

An In-The-Money position may be exercised by the buyer or settled for cash after expiration. A position may become worthless for the buyer if it is Out-of-The-Money at expiration; or a put option seller if the price of the underlying asset crashes to zero.

↗️ Open Interest (OI)

Open Interest (OI) is the total number of lots of open positions, or outstanding options contracts, that have not yet been settled or traded out. OI is equal to the total number of bought or sold options contracts that are still open on the market, and not the total of both added together or the total volume. Increasing open interest represents funds coming into the market while decreasing open interest indicates money flowing out of the market.

↔️ Settlement/Exercise

Option Settlement, or Option Exercise, refers to the final transaction between the buyer and seller, when both parties close their respective positions and exchange the underlying asset for cash tokens or vice versa at the pre-agreed strike price(s). Settlement can occur only after expiration for European style options, but may be triggered at any time by the buyer for an American style option if it is In-The-Money. Settlements can also occur purely in cash tokens in which case the option is said to have been "Cash Settled". Option spreads are always cash settled.

🔄 Liquidity Pool

A Liquidity Pool is a smart contract containing equal (or unequal) amounts of two (or more) different tokens which enables swapping facilities from one token to the other. Traders pay a small fee to the liquidity pool for each swap which is distributed pro-rata to all the liquidity providers who participated in the swap in proportion to their contribution. The swaps are fulfilled without the need for any intermediary or third party. Uniswap V2/V3 liquidity pools also serve as price and liquidity oracles for both the tokens in the pair.

🌊 Liquidity

In DeFi, Liquidity refers to the total amount of funds locked in the liquidity pool available for swapping. The liquidity is the total amount of each token in the pair.

In Uniswap V2 liquidity pools, the liquidity is equally and symmetrically distributed in value between the two tokens (50% each). In Uniswap V3 liquidity pools, the liquidity may be unequally or asymmetrically distributed in value between the tokens.

Since the amount of liquidity in a pool affects the slippage, it directly affects the ease and efficiency with which one token can be converted into the other token without affecting its market price within the liquidity pool. Higher liquidity results in lower slippage and vice versa.

🔮 Oracle

In blockchain parlance, an Oracle is a smart contract that provides any sort of information or data about on-chain or off-chain events which can be programmatically utilized by other smart contracts to perform some operations. The most common type of data provided by oracles are market related information such as token prices or exchange rates and liquidity.

🧙‍♀️ Meta Oracle

A Meta Oracle is an oracle that collates and provides information or data about other oracles. Specifically, in our case: The OptSwap Meta Oracle is a smart contract that observes and retains historic data snapshots of Uniswap V2/V3 oracles (liquidity pools); and is capable of providing current and historic Liquidity & Time Weighted Average Prices (LTWAPs) for any arbitrary token pair. It also supports price aggregation for multiple time durations and observing any untracked Uniswap V2/V3 liquidity pools.

🎱 Spot Price

Spot Price refers to the market price at which an asset was bought or sold, or can be bought or sold, at a particular place and time. The spot price is a critical input for pricing options contracts. Based on the current spot price of the underlying asset, traders are able to make projections about the future price movements of both the underlying asset and associated options contracts.

🎈 Settlement Price

The Settlement Price is the price level at which an option contract will be exercised by the buyer or cash settled at expiration. The settlement price is determined based on the Liquidity & Time Weighted Average Price (LTWAP) of the underlying asset over the past four (4) hours or 240 minutes.

This ensures that the price levels at which the options expire represents the Fair Market Value of the underlying asset and is highly resistant to instantaneous price manipulations towards the last few minutes or seconds. The settlement price may not match the spot price at the time of expiration due to the liquidity & time weighting mechanisms involved.

⏱ Time Weighted Average Price (TWAP)

The Time Weighted Average Price (TWAP) is the average price at which an asset was bought or sold over a specified period of time, called the TWAP Duration. It is said to be "time weighted" because each instantaneous price level over the observed duration is weighted by the amount of time that particular price level existed in the pool.

In general, for large pools over longer periods of time, with no chain congestion, the TWAP is highly resistant to manipulation attacks and represents the on-chain Fair Market Value of the asset over the specified duration.

🧩 Liquidity & Time Weighted Average Price (LTWAP)

The Liquidity & Time Weighted Average Price (LTWAP) is determined by observing the TWAP across multiple liquidity pools and weighting them by the amount of liquidity contained in each respective pool. Since each pool may contain a different amount of liquidity and have slightly different TWAPs, the LTWAP represents a blended on-chain Fair Market Value of the asset. It also protects against any single liquidity pool being potentially manipulated from significantly altering the final settlement prices.

🙆‍♂ Maker & Taker 🙋‍♂️

A Maker is a trader whose buy or sell order sits unfilled or partially filled on the order books waiting for a counterparty. A maker is said to be providing or adding liquidity to the market to "make" trades happen.

A Taker is a trader whose buy or sell orders are matched against a maker to partially or completely fill one or both orders. A taker is said to be removing or "taking" liquidity off the market while having their order filled.

A taker can also become a maker if their order gets partially filled and the remaining lots sit unfilled on the order book for subsequent takers to trade against. In such cases, the trader is a taker for the first part of the order and a maker for the second part.

Every trade involves exactly one maker and one taker. A single order may result in one or more trades against one or more counterparties.

💷 Fees

Fees are the portion of funds paid by users to the protocol or validators/miners for facilitating the trades and settlements to occur. Maker & Taker Fees are based on the premiums traded and are always denominated in cash tokens. The Settlement Fee is based on the total value of the underlying asset to be settled for the option contract and may be paid in the underlying asset or cash tokens depending on the type of position being settled.

Position Conversion Fees are paid by the seller to convert their unlocked positions to locked positions and avail margin minimum benefits based on the margin benefit discount/refund. The Execute Caller Fee is always denominated in OptSwap DAO governance tokens. Gas Fees are denominated in the networks native asset or gas token.

All the fees, except gas fees, are variable and set by on-chain DAO governance proposals. Gas fees are determined by prevailing network conditions.

🔂 Staking

Staking refers to the process of temporarily locking up assets or tokens in a smart contract in exchange for rewards of some kind. Staking is the process by which one can potentially earn a yield or return on their staked assets or tokens.