Under the Hood of Thetanuts Finance v3

Thetanuts Finance
8 min readNov 19, 2023

Our upcoming v3 Upgrade will unlock new possibilities for Trading and Liquidity Provisioning for on-chain options on Thetanuts Finance. With the launch of the v3 Incentivised Alpha envisaged for the coming week, we’re excited to share with the community on what is possible on Thetanuts Finance v3.

Thetanuts Finance first-to-market v3 architecture will feature its existing Basic Vaults, a Lending Market, and Uniswap v3 pools — all housed within the v3 interface. Users need not interact with each of these v3 modules individually, but instead make trades or add liquidity via the trading-focused interface — with interactions with each of these modules abstracted for users. This article also seeks to explain what happens under the hood when different trading strategies are executed on Thetanuts Finance v3.

For a recap on Thetanuts Finance’s first-to-market v3 architecture, please refer to this article.

Key Concepts in Thetanuts Finance v3

Basic Vault LP Tokens at the center of Thetanuts Finance v3

Thetanuts Finance’s v3 architecture uses our existing Basic Vault LP Tokens to extend new use cases in on-chain options trading — enabled by the creation of the Lending Market and existing Uniswap v3 pools, which are all housed within the v3 interface. $XYZ-C (Call Vault LP Token) and $XYZ-P (Put Vault LP Token) represent these tokenized Basic Vault positions, and form the backbone of all trading strategies on Thetanuts Finance v3.

Users that have deposited into the Basic Vaults will mint a Basic Vault LP Token, and can redeem the Basic Vault LP Token by initiating a withdrawal of collateral from their Basic Vault position. This Mint / Redeem mechanism also gives rise to a “Mint Price”, defined as the price of a Basic Vault LP Token when minted or redeemed from a Basic Vault.

Basic Vault LP Tokens Representing Short Positions

Basic Vaults sell out-of-money (“OTM”) European cash-settled options to accredited market makers, and generate yields for users in the form of option premiums. As such, Basic Vault LP Tokens represent short volatility instruments — either as short call or short put positions.

Trading Strategies on Thetanuts Finance v3

While strategies on Thetanuts Finance have traditionally centred around the sell-side, Thetanuts Finance v3 will enable buy-side strategies as well — allowing users to go long or short on on-chain options. Key strategies include:

  • Trading: Long, Short, Close Now, and Close Upon Expiry
  • Liquidity Provisioning via: Basic Vaults Deposit / Withdraw, Lending Market LP, and AMM LP

Collateral

The collateral denominations on Thetanuts Finance v3 are based on the instruments traded. For calls, collateral required is denominated in the underlying asset (i.e. $XYZ) — while for puts, collateral required is denominated in $USDC.

v3 AMM

Thetanuts Finance v3 will utilize battle-tested Uniswap v3 pools to enable users to go long or short on on-chain options. The AMM also gives rise to an “AMM Price” for Basic Vault LP Tokens, defined as the price of a Basic Vault LP Token as set by the relative concentration of assets within the liquidity pool given by the x*y=k formula.

  • For Calls, liquidity pool pairs are denominated as $XYZ/$XYZ-C.
  • For Puts, liquidity pool pairs are denominated as $USDC/$XYZ-P.

v3 Lending Market

The v3 Lending Market contracts were inspired by Aave v2, with the following considerations:

  • Supported Assets: The v3 Lending Market supports $XYZ-C, $XYZ-P, $XYZ, and $USDC assets.
  • Interest Rates: Thetanuts Finance will implement a fixed interest rate model between epochs, which can be changed based on future governance proposals. Interest paid is akin to a synthetic Theta, representing the time decay of an option.
  • Flash Loans: Similar to Aave v2, the v3 Lending Market enables flash loans — allowing users to borrow with up to 95% LTV, implying a theoretical 20x leverage limit on long positions.

Trading Strategies on Thetanuts Finance v3

Short Volatility — Short Call or Put

A short volatility position on Thetanuts Finance represents holding of a Basic Vault LP Token. Upon completion of the short, the user has an option to “Boost” — which deposits the Basic Vault LP Token into the Lending Market.

Short Call: Swap $XYZ on the AMM for $XYZ-C, with $XYZ-C representing a short call position.

Short Put: Swap $USDC on the AMM for $XYZ-P, with $XYZ-P representing a short put position.

Long Volatility — Long Call or Put

A long volatility position on Thetanuts Finance sees a number of steps within the v3 architecture in order to achieve long exposure.

Long Call: $XYZ collateral deposited into the v3 Lending Market. A flash loan for $XYZ-C occurs at a 95% LTV on the Lending Market, with up to 20x of collateral value borrowed. Borrowed $XYZ-C is sold for $XYZ in the AMM, achieving a long call position.

Long Put: $USDC collateral is supplied into the v3 Lending Market. A flash loan of $XYZ-P occurs at a 95% LTV on the Lending Market, with up to 20x of collateral value borrowed. Borrowed $XYZ-P is sold for $XYZ in the AMM, achieving a long put position.

Close Now

Users on Thetanuts Finance v3 can opt to Close Now on their open positions, which has the effect of closing their positions instantly.

Close Now Long Call

  • Thetanuts Finance v3 will route the order to the venue with the best pricing, by querying both the Basic Vaults (for Mint Price) and the AMM (for AMM Price).
  • If AMM Price is more favourable, $XYZ is sold in the AMM for $XYZ-C, with the $XYZ-C loan then being returned to the Lending Market — thereafter, the initial $XYZ position is then withdrawn from the Lending Market.
  • If Mint Price is more favourable, $XYZ will be deposited into the Basic Vault to mint $XYZ-C, with the loan being returned and $XYZ collateral in the Lending Market redeemed.
  • $XYZ in excess of loan repaid represents P&L.

Close Now Long Put

  • Thetanuts Finance v3 will route the order to the venue with the best pricing, by querying both the Basic Vaults (for Mint Price) and the AMM (for AMM Price).
  • If AMM Price is more favourable, $USDC is sold in the AMM for $XYZ-P, with the $XYZ-P loan then being returned to the Lending Market — thereafter, the initial $USDC position is then withdrawn from the Lending Market.
  • If Mint Price is more favourable, $USDC will be deposited into the Basic Vault to mint $XYZ-P, with the loan being returned and $USDC collateral in the Lending Market redeemed.
  • $USDC in excess of loan repaid represents P&L.

Close Now Short Call: Swap $XYZ-C to $XYZ on the AMM. If there is insufficient liquidity in the AMM to facilitate a Close Now, the user can instead close the position Upon Expiry instead.

Close Now Short Put: Swap $XYZ-P to $USDC on the AMM. If there is insufficient liquidity in the AMM to facilitate a Close Now, the user can instead close the position Upon Expiry instead.

Close Upon Expiry

Alternatively, users on Thetanuts Finance v3 can opt to Close Upon Expiry their open positions — which closes the position at the end of the epoch.

Close Upon Expiry Long Call: At the end of the epoch, $XYZ position is deposited into the Basic Vault to generate $XYZ-C — which is used to repay any outstanding debt in the Lending Market. $XYZ in excess of loan repaid represents P&L.

Close Upon Expiry Long Put: At the end of the epoch, $USDC position is deposited into the Basic Vault to generate $XYZ-P — which is used to repay any outstanding debt in the Lending Market. $USDC in excess of loan repaid represents P&L.

Close Upon Expiry Short Call: The user closes the Short Call (i.e. $XYZ-C) at the end of the Basic Vault epoch, and claims the collateral after the epoch ends.

Close Upon Expiry Short Put: The user closes the Short Put (i.e. $XYZ-P) at the end of the Basic Vault epoch, and claims the collateral after the epoch ends.

Considerations for Long Positions on Thetanuts Finance v3

  • User Abstraction: While the steps taken to achieve long exposure on Thetanuts Finance v3 may seem complex, these steps are abstracted under the hood — simplifying the trading experience for users.
  • Theoretical Leverage: While the theoretical leverage based on a 95% LTV is 20x, leverage on Thetanuts Finance v3 is typically in the range of 15–20x — as a result of slippage, price impact, and fees on the AMM.
  • Managing Borrowing Costs: Leveraging in this manner carries inherent risks. The triggers for liquidation on Thetanuts Finance v3 are the accumulating costs from borrowing (i.e. option premiums), rather than market volatility. This is possible given that value of the borrowed asset (i.e. XYZ-C or XYZ-P) can increase due to option premiums and interest payments, each lending position utilizes the underlying asset as collateral.
  • Automatic Rollover: Positions not closed at the end of the epoch will automatically roll over to the new epoch, with any P&L captured in the user’s net position in the lending market.
  • Protocol Solvency: Basic Vaults in Thetanuts Finance are 100% collateralized.

Arbitrage Opportunities on Thetanuts Finance v3

The same Basic Vault LP Token will have both a Mint Price and an AMM Price, which may result in an arbitrage opportunity if they do not trade at the same level. This scenario occurs when the Mint Price > AMM Price for a Basic Vault LP Token, where a user could arbitrage this by:

  • For Calls: Deposit $XYZ in the Basic Vault to mint $XYZ-C; with exposure on Thetanuts Finance v3 achieved by going short call on XYZ. Sell $XYZ-C directly on the AMM, receiving $XYZ.
  • For Puts: Deposit $USDC in the Basic Vault to mint $XYZ-P; with exposure on Thetanuts Finance v3 achieved by going short put on XYZ. Sell $XYZ-P directly on the AMM, receiving $USDC.

Liquidity Provisioning Strategies on Thetanuts Finance v3

Basic Vaults

The Thetanuts Finance v3 interface allows users to get exposure to the Basic Vaults via opening a short call or short put position. By supplying liquidity on the Basic Vaults — Liquidity Providers earn yields in the form of option premiums, and may also earn $NUTS token emissions.

Lending Market (Boosting)

After a user opens a short call or short put position, the user will be prompted to “Boost” — which deposits $XYZ-C or $XYZ-P into the Lending Market. In the future, Thetanuts Finance v3 will enable users to deposit $XYZ and $USDC into the Lending Market for users to generate interest as well. By supplying liquidity on the Lending Market — Liquidity Providers (specifically Lenders) earn yields in the form of lending interest, and may also earn $NUTS token emissions.

AMM (Add Liquidity Module)

Users can add liquidity into the AMM via the Add Liquidity Module, either as $XYZ or $USDC.

Deposit $XYZ (For Calls)

  • 50% deposited into $XYZ-C (earns option premiums), with $XYZ-C Boosted into the Lending Market (earns interest)
  • 50% deposited into AMM as $XYZ (earns AMM trading fees)

Deposit $USDC (For Puts)

  • 50% deposited into $XYZ-P (earns option premiums), with $XYZ-P Boosted into the Lending Market (earns interest)
  • 50% deposited into AMM as $USDC (earns AMM trading fees)

By supplying liquidity on the AMM via the Add Liquidity Module, Liquidity Providers potentially earn yields from up to five different sources — including option premiums from Basic Vaults, lending interest from the Lending Market, trading fees from AMM, potential $NUTS token incentives, and potential additional token incentives.

Concluding Thoughts

If you are as excited for the upcoming v3 Incentivised Alpha as we are, sign up here for early access. Stay tuned for the launch of the v3 Incentivised Alpha envisaged for the coming week, and feel free to reach us on Twitter and Discord.

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Thetanuts Finance

Thetanuts Finance is building a decentralised on-chain options protocol focused on altcoin options 🥜❓