Scholes is a DeFi options trading protocol enabling efficient permissionless minting of options against any ERC20 or LP position and aggregation of options liquidity across all protocols.
CR - Collateralization Ratio LTV - Loan to Value IV - Implied Volatility
Scholes is a DeFi primitive enabling the creation of options markets for any ERC20 token and aggregation of options across options protocols. The key players in the Scholes protocol are Buyers, Underwriters, and Keepers.
Buyers - Options purchasers, users that buy options from the options pool or aggregator for the purpose of trading, hedging, arbitrage, etc.
Underwriters - Options minters, users that mint options against deposited collateral
Keepers - Managers that monitor underwriter CR's for liquidations and update options prices each epoch*
Scholes’ design is quite simple. The three primary components of the protocol are the collateral vaults, option pools, and aggregation contracts.
Collateral vaults - Smart contracts that hold underwriter collateral and enable underwriters to mint options of their choosing. Option Pools - Protocol controlled smart contracts that underwriters mint options into. Options remain in this pool until they are purchased by a buyer, or removed by the Risk Management Module (see Liquidations section for info on RMM)
Aggregator Contracts - Smart contracts that pull in options from external option protocols and mint Scholes options against them. These options can the be freely traded within the Scholes options pools against all liquidity in the protocol.
To mint options, an underwriter must first deposit collateral into a collateral vault. Underwriters must maintain a Loan to Value (LTV) ratio below 65% or their collateral will be liquidated.
Once an underwriter has deposited their collateral into the vault they choose the asset they wish to mint options for, then select the expiration and strike price for the option. The selected inputs are then used to calculate an options price using the Black-Scholes pricing model. Based on this pricing, underwriters may mint a quantity of options up to 65% LTV (Note that if their LTV increases above 65% they will be liquidated).
After selecting the quantity, the underwriter then places their limit or market order and mints their options. Options are minted directly into the option pool corresponding with the contract's strike, expiration, and underlying asset.
For limit order minting, an option is not minted against underwriter collateral until their limit order is taken by a market participant. The order will fail if upon filling the limit order the underwriter’s collateral is no longer sufficient to support the position.
1. Contract expiration - The option contract expires in which case settlement begins 2. Liquidation - The underwriter is liquidated and their remaining collateral is unlocked 3. Option burn - The underwriter purchases their short options from the pool and burns them against their vault to close their position and unlock their collateral
To purchase options, buyers come to the Scholes app and choose the option underlying asset, strike, and expiration they wish to purchase. They will be given the current price of the option based on the options available in the Scholes liquidity hub order book.
Once purchased, the buyer will receive the option contract ERC-1155 token and the premiums paid go into the corresponding option seller’s collateral vaults or protocol the option is being aggregated from.