Options Arbitrage

Main St's primary yield strategy centers on capturing inefficiencies in cryptocurrency options markets through sophisticated volatility prediction models. While the basis trade has become well-known through Ethena's popularization, options arbitrage represents a significant yet undercapitalized opportunity within delta-neutral strategies.

Strategy Mechanics

Our options arbitrage approach focuses on the fundamental relationship between two critical volatility metrics, primarily executed on Deribit, the leading cryptocurrency options exchange:

1. Implied Volatility (IV): The market's expectation of future volatility priced into options premiums

2. Realized Volatility (RV): The actual volatility that occurs over the option's lifetime

The core profit formula for our strategy can be expressed as:

$${\text{P\&L}} = \frac{1}{2} S^2 \Gamma \left( \sigma^2 - \sigma^2_{\text{implied}} \right)$$

The core profit mechanism differs based on our volatility predictions:

Short Volatility Strategy: When our models predict RV will be less than IV, we sell straddles (both calls and puts) to collect premium. This generates profit when markets are less volatile than options pricing suggests.

Long Volatility Strategy: When our models predict RV will exceed IV, we buy straddles to capitalize on underpriced volatility. This generates profit during periods when markets experience greater volatility than expected.

Our machine learning models excel at identifying these volatility mispricing opportunities in both directions, allowing the strategy to adapt to changing market conditions rather than relying solely on collecting volatility premium.

Implementation Framework

Our execution follows a systematic process:

1. Market Analysis: Our proprietary machine learning models analyze historical volatility patterns and market conditions to predict future realized volatility

2. Strategy Selection: We primarily utilize at-the-money straddles (simultaneously buying or selling calls and puts at the same strike price), which begin delta-neutral without requiring immediate hedging

3. Dynamic Hedging: As underlying prices move, we implement real-time delta hedging to maintain neutrality, protecting against directional exposure

4. Risk Management: Sophisticated monitoring of critical option Greeks (Delta, Gamma, Theta, Vega) ensures portfolio stability and targeted risk parameters

Market Opportunity

The cryptocurrency options market has grown substantially, with Bitcoin options open interest approaching $35 billion - nearly comparable to futures markets. This deep liquidity allows our strategy to scale significantly while maintaining execution efficiency.

Like the basis trade, which generates profit by financing market demand for futures, options markets also exhibit a market premium from structural factors including:

1. Term Structure Dynamics: Due to stochastic volatility, the forward curve typically slopes upward, creating sustainable premium harvesting opportunities

2. Market Inefficiency: Implied volatility can regularly become disconnected from realized volatility

3. Systematic Demand: Institutional investors regularly overpay for downside protection, thus creating persistent options mispricings

Performance Profile

Options arbitrage strategies exhibit a unique performance profile:

1. Higher yield potential than traditional basis trades, especially in volatile market environments

2. Statistical rather than deterministic returns, creating occasional drawdowns offset by larger cumulative gains

3. Performance smoothed through portfolio diversification across multiple expirations and underlying assets

Current testing demonstrates annual returns exceeding 35% after all fees, with results continuously optimized through machine learning model refinements.

All yield figures based on historical or modeled performance are subject to change based on market conditions. Past performance does not guarantee future results.

While options arbitrage forms Main St's core yield engine, we maintain flexibility to incorporate supplementary strategies that enhance portfolio diversification and stability.