7 ms·

Show HN: Bitcoin derivatives – call and put options

95 points by ciscoriordan 13y ago

mrmch 13y ago
Looks cool (like the Authy integration), but you might want to make the Guide a little more visible (https://derivabit.com/guide https://derivabit.com/guide). That was the first thing I was looking for.
Tycho 13y ago
So... counterparty risk?
- ciscoriordan 13y ago
  For now, steep option seller margin requirements. 100% of the underlying Bitcoin for calls, 20% for puts.
  - noname123 13y ago
    Why 20% for puts? Although loss for puts is capped at 100% of margin value, BTC is as much liable to go up 20% or 20% in a short period of time. How often is margin calculation done? And what is the time period allowed for option sellers to cover their margin? Also, what happens if my counterparty can't pay? Is the exchange going to step in and guarantee the trade?
    - ciscoriordan 13y ago
      The margin is a percentage of the underlying Bitcoin. So no margin calls. If your counterparty can't pay, then you get the full value of their margin account for that trade (plus the premium payment, which you already received) and no more.
      - noname123 13y ago
        I see. Let's suppose I own a 1 contract (x100 BTC multiplier) of BTC/USD put contract at strike price $100 BTC/USD when BTC is trading at $100 USD with expiration two months from today (an at the money put). As part of initial margin requirement to enter the trade, the seller has to put down 20 BTC or cash equivalent of $2,000. Suppose BTC drops 40% in value or $60 in one month, now the notional value of my BTC contract should be $40/BTC or $4,000/contract. Not only does 20 BTC valued at the original value of $2,000 no longer cover the mark-to-market value of my put contract, its market value at $1,200 covers even less that requirement. Now suppose I'm nervous because I'm sitting on a contract that should be worth 4K when the collateral of my counterparty is only worth 1.2K. Also since I bought a put which means that I'm betting against BTC, that would only make me more nervous about counter-party risk; and I'd demand my counter-party to put up more collateral. However, if the exchange isn't willing to extract from my counter-party and isn't willing to step in. Then, I have no confidence in such a market.
  - mcphilip 13y ago
    So only selling covered calls are allowed, in other words?
    - rjtavares 13y ago
      "Covered calls" are covered by the underlying asset. That's not the same as a 100% margin requirement.
      - this_user 13y ago
        From the call writer's perspective it's indistinguishable from a covered call transaction. This also greatly reduces the service's usefulness as you are unable to implement many standard option strategies.
        rjtavares 13y ago
        The initial transaction, yes, but not the final payoffs. I agree with you on the other issue (though you borrow money elsewhere to simulate a lower margin).
    - deleted 13y ago
      [deleted]
  - filearts 13y ago
    It seems conceptually crazy to me to buy a put option in such a system where I would be exposed to USD/BTC as well as having no recourse against an anonymous issuer (for 80% of the underlying price). How do the site's creators think market participants will handle these conditions?
    - ciscoriordan 13y ago
      Right now the market can bake those risks into the option prices. Also, if there is demand for different margin requirements we'll add contracts with those requirements.
      - filearts 13y ago
        It will be pretty interesting to see what spread emerges between calls and puts in these circumstances. Care to speculate? ;-)
    - bayesianhorse 13y ago
      That's the problem with learning all about options before actually caring for the reason they exist: risk management. Options can be replicated with a portfolio, which usually requires a certain minimum size. Investors with a lesser budget would then buy the smaller units of "risk management". In a way portfolio management through risk diversification isn't free lunch. For example if an investor has $1000 he can't realize a portfolio weight of 10% in a stock that is worth more than $100 per share.
- jmtame 13y ago
  Are you Scott Hansen? Or just a fan of the musician? Just curious.
  - Tycho 13y ago
    Neither. Name is from an AI character in a game called Marathon. Which was in turn named for the historical scientist/astronomer.
- mlubin 13y ago
  A couple of projects have looked at solving the trust issue by implementing a distributed exchange without counterparty risk on top of the bitcoin blockchain: https://www.counterparty.co/ https://www.counterparty.co/ http://www.mastercoin.org/ http://www.mastercoin.org/. The idea is that the protocol itself handles escrow and matching orders instead of going through a centralized exchange.
  - oillio 13y ago
    This might be workable with an exchange (there still needs to be trust in the guy holding the USD). However, options markets require margin accounts. It is pretty hard to offer anyone credit without a lot of trust.
simon_ 13y ago
I will be interested to see if this works. Best of luck to you, but I am skeptical. For an options market to work you need both buyers and sellers of volatility. Is anyone really going to show up to sell vol here? At what kind of price? Even if we assume that BTC is infinitely liquid and sellers of options could do theoretically perfect dynamic hedging, my guess is that implied vol is so extremely high that prices will look crazy and expensive to potential options buyers.
topynate 13y ago
It's not obvious that you need to verify your identity to withdraw. It would be very easy for someone to see a deposit address and assume withdrawals would be just as friction-less.
- ciscoriordan 13y ago
  I've added copy to the guide and the deposit modal making that more clear.
bjterry 13y ago
I would be very careful with using this for risk management. It has very different characteristics from exchange-traded options contracts that you may be familiar with in the US. Purchasing call options is pretty safe (excluding security risks, of course), but purchasing put options is quite dangerous. They have a margin requirement of 20% on put options that are written by users, but critically, this is the maximum amount of liability the put writer is taking on. So it's actually not a put you are buying, but a "bear put spread" with a lower leg 20% below the upper leg. This makes it unsuitable for managing tail risk, which, for bitcoins, is significant. For example, if you had bought a contract at $1100 which is roughly the top of the bitcoin market in December, and it fell to $600, you would only be covered for $220, and would be out $280 plus the cost of the contract (Edit: apparently this isn't correct, in another comment they say that you get the cost of the contract back). The fact that they require 100% margin on call options isn't as much of a concern (for simple risk management applications), because you still gain the exposure to the underlying bitcoins. It would be like if the exchange required you to submit 100 shares of MSFT to them to open the call contract, rather than using cash settlement. It's not good for liquidity because it makes it hard to be an options trader, but there will be very little liquidity anyway the way it's set up currently. Another concern is that the guide doesn't disclose what they use as the underlying price for the contract, what exchange they use as the benchmark. It should also be noted that they appear to require photo id in order to withdraw any funds from your wallet, which is likewise not disclosed in their guide.
- simon_ 13y ago
  I was going to write a response disagreeing based on the assumption that, like any normal exchange, Derivabit would fully intermediate the trade. But after reading the guide, I realize you are correct! They explicitly say the maximum you could ever recover on your put option is the 20% margin. In my opinion this is extremely misleading and to call such a contract a "put" and hide the real definition in a FAQ is straightforwardly wrong.
- bjterry 13y ago
  I just noticed that they don't actually provide an order book or any sort of bid-ask spread information. That makes price discovery extremely challenging, and makes this even more difficult for providers of liquidity (traders, dealers, etc.). Charitably, I assume this is coming and they haven't had time to implement it yet.
jboggan 13y ago
What's the legality of this operation in terms of your base of operation and location of customers you are serving? Did you guys have to get a MSB license or similar oversight? Or do you think this falls into an unregulated area? Edit: I also wanted to add, are you serving as counterparty to any customer transactions (for providing liquidity) or are you working with any sort of market makers?
- ciscoriordan 13y ago
  We only support Bitcoin derivative instruments, which we believe to be under the CFTC's jurisdiction (http://www.law.cornell.edu/uscode/text/7/2 http://www.law.cornell.edu/uscode/text/7/2).
  - jboggan 13y ago
    Did you guys already get registered as a designated contract market?
dia80 13y ago
History says if you send any bitcoins to derivabit you will duly be relieved of them by some hacker.
- panarky 13y ago
  Seriously, the last two years are littered with the corpses of Bitcoin exchanges, wallets and trading platforms. Why would anyone send Bitcoin to a new site at this point? Wouldn't the first priority be to establish escrow with a trusted third party, or use m-of-n transactions? At the very least, build the site with full transparency so you can prove publicly, every 24 hours, that you control the private keys to all Bitcoins entrusted to you.
  - kartman 13y ago
    We use m of n locked contracts on our site, so you dont need to trust the exchange with bitcoin https://www.cointures.com https://www.cointures.com
JumpCrisscross 13y ago
Former volatility market maker here. Interesting concept, one I have considered playing with myself. Issues I see so far: (1) Not compliant. No SIPC coverage for customer funds and no SEC registration. This is a bigger problem for Derivabit than Mt Gox. First, it appears they are U.S.-based. Second, derivatives are closer to the U.S. definition of securities than crypto-currencies. (2) Underlying price determination. I see the current spot price as $587. Where is this coming from? American options are continuous-time derivatives. These are sensitive to price information disruptions. Perhaps consider European or binary options? (3) No rates or collateral markets. Options market makers need rates and collateral markets to provide liquidity and correct market aberrations through arbitrage. Rates markets are venues where one can borrow and lend capital, in BTC or U.S. dollars, to conduct Bitcoin market activity. Collateral markets are venues where one can borrow and lend Bitcoins. Non-linear derivatives market participates need collateral markets to manage their risks. Without collateral markets, volatilises for puts and calls will diverge and the market's robustness will suffer. The lack of rates and collateral markets also makes this market vulnerable to some well-known predatory trading tactics. (4) Counterparty risk. U.S. exchange-traded equity options are centrally cleared through the Options Clearing Corporation (the "OCC"). Whether the writer of a contact pays up is irrelevant to the buyer - the OCC always pays everyone. Several layers of reserves and guarantees enhance the creditworthiness of the OCC. Counterparty credit is likely a greater risk than volatility for a Derivabit contract.
- sillysaurus3 13y ago
  I'd like to pick your brain some more, but I don't have any specific questions at this point. Would you mind continuing to talk more about this space? It's something I'm very interested in, so if you can think of more than those 4 (excellent) points then that would be very helpful. Thank you! EDIT: That goes for everyone else reading this too, of course. If you have any experience or thoughts in this area, please chime in.
- csense 13y ago
  What exactly is a "rates market"? Can you provide an example of a market that fulfills this function?
michaelgrosner2 13y ago
Is there any API to speak of?
- ciscoriordan 13y ago
  Not yet, it's on the roadmap. Contact info in my profile.
oscilloscope 13y ago
Quick question about MtGox data, since the relevant crowd may be here. Do the activities of User 15 in these charts appear to have anything to do with options trading? http://bitcoin.stamen.com/ http://bitcoin.stamen.com/
- ciscoriordan 13y ago
  To me that looks like attempted manipulation of the spot rate.
bayesianhorse 13y ago
There are reasons why this kind of thing is usually regulated. For excellent historical and introductory material, look at the coursera course "Financial Markets" from Yale (also on Youtube). Actually while I have never seen a legitimate use for binary options elsewhere, they are more attractive in the bitcoin domain, where you really really want to limit downside risk. even at the expense of all other aspects of risk management...

95 points by ciscoriordan 13y ago

mrmch 13y ago

Looks cool (like the Authy integration), but you might want to make the Guide a little more visible (https://derivabit.com/guide https://derivabit.com/guide). That was the first thing I was looking for.

Tycho 13y ago

So... counterparty risk?

ciscoriordan 13y ago
For now, steep option seller margin requirements. 100% of the underlying Bitcoin for calls, 20% for puts.
- noname123 13y ago
  Why 20% for puts? Although loss for puts is capped at 100% of margin value, BTC is as much liable to go up 20% or 20% in a short period of time. How often is margin calculation done? And what is the time period allowed for option sellers to cover their margin? Also, what happens if my counterparty can't pay? Is the exchange going to step in and guarantee the trade?
  - ciscoriordan 13y ago
    The margin is a percentage of the underlying Bitcoin. So no margin calls. If your counterparty can't pay, then you get the full value of their margin account for that trade (plus the premium payment, which you already received) and no more.
    - noname123 13y ago
      I see. Let's suppose I own a 1 contract (x100 BTC multiplier) of BTC/USD put contract at strike price $100 BTC/USD when BTC is trading at $100 USD with expiration two months from today (an at the money put). As part of initial margin requirement to enter the trade, the seller has to put down 20 BTC or cash equivalent of $2,000. Suppose BTC drops 40% in value or $60 in one month, now the notional value of my BTC contract should be $40/BTC or $4,000/contract. Not only does 20 BTC valued at the original value of $2,000 no longer cover the mark-to-market value of my put contract, its market value at $1,200 covers even less that requirement. Now suppose I'm nervous because I'm sitting on a contract that should be worth 4K when the collateral of my counterparty is only worth 1.2K. Also since I bought a put which means that I'm betting against BTC, that would only make me more nervous about counter-party risk; and I'd demand my counter-party to put up more collateral. However, if the exchange isn't willing to extract from my counter-party and isn't willing to step in. Then, I have no confidence in such a market.
- mcphilip 13y ago
  So only selling covered calls are allowed, in other words?
  - rjtavares 13y ago
    "Covered calls" are covered by the underlying asset. That's not the same as a 100% margin requirement.
    - this_user 13y ago
      From the call writer's perspective it's indistinguishable from a covered call transaction. This also greatly reduces the service's usefulness as you are unable to implement many standard option strategies.
      - rjtavares 13y ago
        The initial transaction, yes, but not the final payoffs. I agree with you on the other issue (though you borrow money elsewhere to simulate a lower margin).
  - deleted 13y ago
    [deleted]
- filearts 13y ago
  It seems conceptually crazy to me to buy a put option in such a system where I would be exposed to USD/BTC as well as having no recourse against an anonymous issuer (for 80% of the underlying price). How do the site's creators think market participants will handle these conditions?
  - ciscoriordan 13y ago
    Right now the market can bake those risks into the option prices. Also, if there is demand for different margin requirements we'll add contracts with those requirements.
    - filearts 13y ago
      It will be pretty interesting to see what spread emerges between calls and puts in these circumstances. Care to speculate? ;-)
  - bayesianhorse 13y ago
    That's the problem with learning all about options before actually caring for the reason they exist: risk management. Options can be replicated with a portfolio, which usually requires a certain minimum size. Investors with a lesser budget would then buy the smaller units of "risk management". In a way portfolio management through risk diversification isn't free lunch. For example if an investor has $1000 he can't realize a portfolio weight of 10% in a stock that is worth more than $100 per share.
jmtame 13y ago
Are you Scott Hansen? Or just a fan of the musician? Just curious.
- Tycho 13y ago
  Neither. Name is from an AI character in a game called Marathon. Which was in turn named for the historical scientist/astronomer.
mlubin 13y ago
A couple of projects have looked at solving the trust issue by implementing a distributed exchange without counterparty risk on top of the bitcoin blockchain: https://www.counterparty.co/ https://www.counterparty.co/ http://www.mastercoin.org/ http://www.mastercoin.org/. The idea is that the protocol itself handles escrow and matching orders instead of going through a centralized exchange.
- oillio 13y ago
  This might be workable with an exchange (there still needs to be trust in the guy holding the USD). However, options markets require margin accounts. It is pretty hard to offer anyone credit without a lot of trust.

simon_ 13y ago

I will be interested to see if this works. Best of luck to you, but I am skeptical. For an options market to work you need both buyers and sellers of volatility. Is anyone really going to show up to sell vol here? At what kind of price? Even if we assume that BTC is infinitely liquid and sellers of options could do theoretically perfect dynamic hedging, my guess is that implied vol is so extremely high that prices will look crazy and expensive to potential options buyers.

topynate 13y ago

It's not obvious that you need to verify your identity to withdraw. It would be very easy for someone to see a deposit address and assume withdrawals would be just as friction-less.

ciscoriordan 13y ago
I've added copy to the guide and the deposit modal making that more clear.

bjterry 13y ago

I would be very careful with using this for risk management. It has very different characteristics from exchange-traded options contracts that you may be familiar with in the US. Purchasing call options is pretty safe (excluding security risks, of course), but purchasing put options is quite dangerous. They have a margin requirement of 20% on put options that are written by users, but critically, this is the maximum amount of liability the put writer is taking on. So it's actually not a put you are buying, but a "bear put spread" with a lower leg 20% below the upper leg. This makes it unsuitable for managing tail risk, which, for bitcoins, is significant. For example, if you had bought a contract at $1100 which is roughly the top of the bitcoin market in December, and it fell to $600, you would only be covered for $220, and would be out $280 plus the cost of the contract (Edit: apparently this isn't correct, in another comment they say that you get the cost of the contract back). The fact that they require 100% margin on call options isn't as much of a concern (for simple risk management applications), because you still gain the exposure to the underlying bitcoins. It would be like if the exchange required you to submit 100 shares of MSFT to them to open the call contract, rather than using cash settlement. It's not good for liquidity because it makes it hard to be an options trader, but there will be very little liquidity anyway the way it's set up currently. Another concern is that the guide doesn't disclose what they use as the underlying price for the contract, what exchange they use as the benchmark. It should also be noted that they appear to require photo id in order to withdraw any funds from your wallet, which is likewise not disclosed in their guide.

simon_ 13y ago
I was going to write a response disagreeing based on the assumption that, like any normal exchange, Derivabit would fully intermediate the trade. But after reading the guide, I realize you are correct! They explicitly say the maximum you could ever recover on your put option is the 20% margin. In my opinion this is extremely misleading and to call such a contract a "put" and hide the real definition in a FAQ is straightforwardly wrong.
bjterry 13y ago
I just noticed that they don't actually provide an order book or any sort of bid-ask spread information. That makes price discovery extremely challenging, and makes this even more difficult for providers of liquidity (traders, dealers, etc.). Charitably, I assume this is coming and they haven't had time to implement it yet.

jboggan 13y ago

What's the legality of this operation in terms of your base of operation and location of customers you are serving? Did you guys have to get a MSB license or similar oversight? Or do you think this falls into an unregulated area? Edit: I also wanted to add, are you serving as counterparty to any customer transactions (for providing liquidity) or are you working with any sort of market makers?

ciscoriordan 13y ago
We only support Bitcoin derivative instruments, which we believe to be under the CFTC's jurisdiction (http://www.law.cornell.edu/uscode/text/7/2 http://www.law.cornell.edu/uscode/text/7/2).
- jboggan 13y ago
  Did you guys already get registered as a designated contract market?

dia80 13y ago

History says if you send any bitcoins to derivabit you will duly be relieved of them by some hacker.

panarky 13y ago
Seriously, the last two years are littered with the corpses of Bitcoin exchanges, wallets and trading platforms. Why would anyone send Bitcoin to a new site at this point? Wouldn't the first priority be to establish escrow with a trusted third party, or use m-of-n transactions? At the very least, build the site with full transparency so you can prove publicly, every 24 hours, that you control the private keys to all Bitcoins entrusted to you.
- kartman 13y ago
  We use m of n locked contracts on our site, so you dont need to trust the exchange with bitcoin https://www.cointures.com https://www.cointures.com

JumpCrisscross 13y ago

Former volatility market maker here. Interesting concept, one I have considered playing with myself. Issues I see so far: (1) Not compliant. No SIPC coverage for customer funds and no SEC registration. This is a bigger problem for Derivabit than Mt Gox. First, it appears they are U.S.-based. Second, derivatives are closer to the U.S. definition of securities than crypto-currencies. (2) Underlying price determination. I see the current spot price as $587. Where is this coming from? American options are continuous-time derivatives. These are sensitive to price information disruptions. Perhaps consider European or binary options? (3) No rates or collateral markets. Options market makers need rates and collateral markets to provide liquidity and correct market aberrations through arbitrage. Rates markets are venues where one can borrow and lend capital, in BTC or U.S. dollars, to conduct Bitcoin market activity. Collateral markets are venues where one can borrow and lend Bitcoins. Non-linear derivatives market participates need collateral markets to manage their risks. Without collateral markets, volatilises for puts and calls will diverge and the market's robustness will suffer. The lack of rates and collateral markets also makes this market vulnerable to some well-known predatory trading tactics. (4) Counterparty risk. U.S. exchange-traded equity options are centrally cleared through the Options Clearing Corporation (the "OCC"). Whether the writer of a contact pays up is irrelevant to the buyer - the OCC always pays everyone. Several layers of reserves and guarantees enhance the creditworthiness of the OCC. Counterparty credit is likely a greater risk than volatility for a Derivabit contract.

sillysaurus3 13y ago
I'd like to pick your brain some more, but I don't have any specific questions at this point. Would you mind continuing to talk more about this space? It's something I'm very interested in, so if you can think of more than those 4 (excellent) points then that would be very helpful. Thank you! EDIT: That goes for everyone else reading this too, of course. If you have any experience or thoughts in this area, please chime in.
csense 13y ago
What exactly is a "rates market"? Can you provide an example of a market that fulfills this function?

michaelgrosner2 13y ago

Is there any API to speak of?

ciscoriordan 13y ago
Not yet, it's on the roadmap. Contact info in my profile.

oscilloscope 13y ago

Quick question about MtGox data, since the relevant crowd may be here. Do the activities of User 15 in these charts appear to have anything to do with options trading? http://bitcoin.stamen.com/ http://bitcoin.stamen.com/

ciscoriordan 13y ago
To me that looks like attempted manipulation of the spot rate.

bayesianhorse 13y ago

There are reasons why this kind of thing is usually regulated. For excellent historical and introductory material, look at the coursera course "Financial Markets" from Yale (also on Youtube). Actually while I have never seen a legitimate use for binary options elsewhere, they are more attractive in the bitcoin domain, where you really really want to limit downside risk. even at the expense of all other aspects of risk management...