Suitable when you are moderately bullish or neutral about the underlying
A covered call is a financial strategy wherein the investor selling the option owns an equivalent amount of the underlying security.
Selling a covered call is suitable when you are moderately bullish or neutral about the underlying. It is an ideal way to earn additional income for someone who intends to hold the underlying for longer periods but does not expect an appreciable price increase in the near term. The maximum profit potential of a covered call is equivalent to the premium received for the options sold, plus the potential upside in the underlying between the current spot price and the strike price.
A covered call strategy can be created by holding a long position on an asset and then selling call options. Covered calls can be used regularly to add several percentage points of cash income to your annual returns from the underlying.
A covered call strategy entails moderate risk as the trader's ownership of the underlying can serve as a cover if the call option expires in the money. Olive Covered Call Vaults, in its present design, relies on Opyn oTokens. oTokens are ERC20 token representations of an options contract, where each of them has a strike price and expiry. The vault’s collateral is locked until the expiry of the oToken. This collateral is used to pay off oToken holders in the case that the options expire in the money. Opyn options are cash settled, so if the options expire ITM, there is no transfer of the underlying: the difference between the strike and the market price at expiry will be compensated by liquidating part of the deposits. This mechanism ensures there is no credit risk.
However, smart contract risk and principal risk still exist.
Smart Contract Risk
There is a risk of smart contract failure in the underlying vault or in the protocol partners we work with, for example, pricing oracles. We aim to reduce smart contract risk by - undergoing frequent audits, organising bug bounties and by only interacting with other audited DeFi protocols.
If the underlying asset of the covered call moons ~ more than 30% within a week, the options seller will be obligated to still sell the underlying asset at the strike price. But even in this case, the options seller will still be up tremendously in dollar terms as the difference between the spot price at initiation and the options premium will remain with the options seller.
Covered call's scalability and sustainability depend on the depth of the derivatives market. The global derivatives market being $1.2 quadrillion means we can sustainably scale to a large TVL before the yields start to get affected by our size. We also constantly look to onboard top market makers so that we can get the best quotes on our strategies.
The fee structure consists of a 2% management fee and a 10% performance fee. The management fee is applied as a percentage of the total assets in the vault, while the performance fee is applied to the premium received or yield generated by the vault every week.
Suppose you invested 1 WETH in the WETH Covered Call Vault. Assuming WETH is at $2000, the strike price for the call option is $2500, and the premium is at 0.0045 WETH.
The management fee is charged pro-rata annually @ 2%, i.e. 2%/52 Weeks = 1 WETH x 0.02/52 = 0.00038 WETH. Since the performance fee is only charged when the expiry happens out of the money or the week was profitable, it will equal 0.0045 x 0.1, i.e. 0.00045 WETH.
The net gain made by the users is therefore 0.0045 - 0.00045 - 0.00038 = 0.00367 WETH which is ~ 20.9% APY net of fees.