Market Making Vaults
PsyFinance has introduced a market making vault that generates returns for its depositors by acting as a market maker for PsyFinance option markets. The vault generates yield by collecting $USDC as a deposit asset, then bidding on the open vault auctions within the PsyFinance ecosystem. The vault bids on vault auctions only if there are no existing bids within 10% of a matching option market bid on Zeta Markets.
The vault will sell the equivalent amount of options on Zeta Markets, aiming to create a delta neutral or risk limited trade. The difference between the purchase price of the options acquired through vault bidding, and selling price of the options through Zeta will determine how much USDC the vault can generate weekly, and therefore the yield.
If the vault has excess deposits not being used for active market making strategies - those funds will be deposited into Solend to earn yield and improve capital efficiency and vault performance.
Examples of Market Making Strategies
Delta Neutral Trades - As discussed above, if the vault has purchased options and the equivalent strike exists on Zeta the vault will sell the corresponding amount of options creating a delta neutral trade. In this trade there is no price risk of the underlying asset.
Risk Limited Trades - There may be situations which the options acquired by the vault do not line up exactly with the liquidity available on Zeta (for example vault acquires SOL 45 Calls an Zeta order book is showing SOL 44 Call). In these situations the vault will enter into a risk limited spread trade, for example by buying the SOL-45-C and selling an equivalent or lower amount of SOL-44-C. The maximum loss during such epoch will be capped at the higher strike (e.g. (45-44)/45=2.22% for each call spread sold). Risk limited trades may incur up to 5% price risk each epoch. In return for their higher risk these trades generally generate increased returns to the delta neutral trades.
Liquidity Provisioning Trades - During times when options are close to expiry (1-2 days), there is occasionally demand for options to close off positions on the Zeta order book. These options are typically <0.001 Delta, which roughly translates to there being less than 0.01% chance of expiring in-the-money. These option buyers would typically pay a premium far in excess of the fair price of these options, as they require the liquidity to rollover positions. The vault automatically detects such trades and would sell naked options that are close to expiry and have a 99.99% chance of ending in a profit. No more than 25% of the vault deposits will enter into these trades to limit risk exposure. The vault will also rebalance these positions in the event of large underlying price movements.
What are the risks if I deposit in this vault?
With the current implementation of the vault, there is limited price risk for depositors based on underlying asset price. The vault will have a preference for Delta Neutral trades, followed by risk limited trades with a maximum loss per epoch of 5% if none of the latter exist.
Certain other risks do exist that are important to understand. There may not be sufficient liquidity on Zeta's orderbook to clear all options bought profitably. There are also smart contract risks, such as exploits or hacks, and oracle price feed risks between protocols, which may impact the money-ness of the options These risks are mitigated by audits on both PsyFinance, Zeta Markets and Solend's platforms.
How does the Market Maker Vault help Option Vault depositors?
The market making vault acts as a backstop to ensures that vault auctions are clearing at least 10% off of what's being quoted on Zeta Markets. This should guarantee higher yields for PsyFi Option Vault depositors.
How do you prevent liquidations on short position on Zeta Markets? The vault sells options on Zeta using Zeta's margining system, while holding purchased options in its program account. Although risk is limited across both markets, in periods of high volatility the margin requirements on Zeta may exceed the deposits available to the vault. In such cases, the PSYDO will provide short term capital to act as a backstop, up to 100,000 USDC, to prevent liquidations.
What happens if the Market Maker Vault does not win any bids?
If option auctions are very competitive the Market Maker Vault may not purchase any or enough options to generate substantial yield. In those cases the vault will deposit excess funds on a lending protocol such as Solend to continue to generate yield for users.
Why can't I withdraw funds during the weekly epoch from the Market Maker Vault?
Since the marker vault uses deposited assets as margin to sell the purchased options, those funds are locked until expiry, which is 0800 UTC every Friday. Users can withdraw during the epoch similar to existing vaults, and the withdrawal will be automatically sent to their wallet at the end of the epoch.
What is the projected yield of the Market Maker Vault?
The estimated yield of this vault is between 3% to 10+% APY, depending on overall capital deployment in making making strategies. We expect lower yields in weeks when undeployed funds are deposited into a lending protocol, and higher yields in weeks when funds are deployed into delta-neutral and risk-limited trades.
What are the fees charged for the Market Maker Vault?
There is a 10% performance fee on yield for epochs with positive returns. There are no management or withdrawal fees charged for this vault.
Why are deposits capped at a maximum of 200,000 USDC?
We are capping deposits to 200k USDC in order to maximize yield for depositors. The amount of options purchasable each week is limited by the overall option vaults TVL. We will be utilizing leverage on Zeta's margin account in order to sell the corresponding options, which improves capital efficiency. As TVL on PsyFinance vaults grow, we expect this cap to be raised correspondingly.