When you lend tokens through a covered call, you are essentially capping your potential gains by writing a call option.
For example, if you decide to lend your tokens for 30 days with a relative strike price of 110%, it means that if the token's price increases by more than +10% during those 30 days, you will still receive only 110% of the original notional value. Even if the token's price were to increase by 50%, your position value would remain at 110% of the initial notional value. On the other hand, if the token's price doesn't increase by more than 10% during the 30 days, you will simply get back the tokens you initially lent. Therefore, you're choosing to limit your participation in the token's upside potential up to a certain level, and in exchange for forgoing additional gains, you receive compensation upfront.
It's important to note that the token's price is inherently uncertain, and neither party knows in advance whether the call option will expire in the money or become worthless. Both parties can only estimate the call option's value probabilistically, generally considering that the more volatile the token, the more valuable the call option becomes, as there is a higher chance that it may expire in the money.
MYSO has onboarded several professional market makers, who take the other side of the trade and employ various strategies to make money.
One reason why market makers are willing to provide upfront cash for borrowing tokens is because these tokens enable them to seize arbitrage opportunities, such as price differences between different exchanges or between spot and perpetual contract prices. Additionally, market makers utilize a strategy called "gamma scalping" to take advantage of price fluctuations in the value of the call option. This strategy enables them to profit from the volatility of the underlying token without committing to a specific directional view.
Gamma scalping is a technique that takes advantage of fluctuations in the value of a call option.
When the token price rises, the value and "delta" of the call option also increase. In this scenario, it becomes more likely that the call option will expire in the money, and the market maker will not be able to reclaim their cash collateral. Consequently, market makers can sell a portion of the tokens to offset the gains from the call option. Conversely, when the price falls, the value and delta of the call option decrease. In this case, the market maker must buy back the tokens they previously sold to return the borrowed tokens and recover their cash collateral. This approach allows market makers to profit from price movements without making directional bets. However, it's essential to note that profits are not guaranteed and depend greatly on the volatility of the underlying token.
It would be disadvantageous for market makers to sell all borrowed tokens at once. Doing so would drive down the underlying token's price and create unfavorable selling conditions for the market maker.
Instead, they may prefer to sell only a portion of the borrowed tokens and do so gradually over time. If the token price decreases, they eventually need to buy back some tokens before the loan expires to ensure they can repay the loan and recover their cash collateral. It's important to note that there's no guarantee they will be able to repurchase tokens at a lower price than they initially sold them for. In fact, immediate selling and dumping of tokens would result in a poor average sell price, potentially leading to significant losses.
If market makers hastily sold all the borrowed tokens, causing prices to plummet, they would eventually need to buy back those tokens. However, with other market participants aware of their urgent need to purchase tokens, this could trigger a short squeeze, making it challenging for them to repurchase tokens at reasonable prices. In such scenarios, they may be unable to recover their cash collateral and could incur substantial losses. Therefore, it is not in their best interest to do so.
Market makers employ a strategy known as "delta hedging." This involves evaluating the price sensitivity of the call option in response to changes in the underlying token's price.
To maintain a "market-neutral" position, market makers sell some tokens when the price increases and buy tokens when the price decreases. This practice helps offset the value of the call option. For example, if the underlying token's price rises, the call option becomes more valuable, increasing the likelihood of it expiring in the money. In this scenario, market makers can offset the gains on the call option by selling the underlying token. Conversely, if the token's price falls, the call option becomes less valuable, making it less likely that market makers will exercise it. In such cases, they need to buy tokens to recover their cash collateral.