High-level model for the returns to providing liquidity in Uniswap v2 liquidity pools. There are two assets X and Y in the pool with reserves x and y of each, with pool constant k = x * y and price p = x / y.
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If the hedge is futures, you trade short gamma by dynamically hedging as IL moves up and down. So an option is a more direct hedge to buy that gamma. You then need to compare IV of the option to RV of the asset (that results in LP fees). It may be better to just sell the option!
You’d still need to adjust the options hedge over time right? Since the payoffs are nonlinear in different ways. LP token vs long straddle sounds like a fun RV strat though. Paging @joshgiersch to the thread, you’ll probably enjoy the degeneracy.
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Also I don't think there's much of an options market in anything weirder than ETHUSD. It's a bit unusual, but my vibe is that price discovery in altcoin vol (such as it is) mostly occurs through liquidity pools?
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Yes, indeed, you would probably need stable gamma across time and strikes. Something like a rolling variance swap, which of course doesn't exist. But even a single option that you roll every so often is arguably better than a linear futures hedge.
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And agree on LP vs options being an interesting RV strat.https://twitter.com/markosp/status/1409493050884231171?s=19 …
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V3 would make it even more interesting, as you can be LP in bigger size in a range and buy OTM against that to protect against IL if it exits the range.
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I’m still wondering which way the price discovery would work - would the Uniswap LPs drive the price of options, or would the options market drive Uniswap liquidity provision, or would there be no connection between the two and vol-arb funds having a field day…
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