We would like to thank the TMC for their review and are excited about the opportunity to work with the Arbitrum Community.
We recognize that some community members have highlighted challenges in casting an informed vote on the single-side ARB strategy due to the lack of publicly available strategies (see link, link). As such, we would like to provide additional information to help the community better understand the strategy and address the points raised by the TMC.
The proposed ARB-only strategy is centered around covered calls—specifically, selling call options on ARB to generate immediate stablecoin income through the MYSO v3 deployment on Arbitrum. Importantly, there’s no off-chain funds movement (as suggested in the TMC feedback) but full on-chain transparency with regards to option settlement.
Below, we outline key aspects of the strategy to aid decision-making:
- Rationale for proposing covered calls
- Explanation of covered calls and their mechanics
- How we propose implementing a covered call strategy for the Arbitrum community
- Risks associated with covered calls and how we intend to manage them
- Steps to operationalize the strategy
- Feedback
1) Rationale for Proposing Covered Calls
We believe covered calls are a useful instrument for the Arbitrum treasury for the following reasons:
- Yield Generation with ARB Alone: This approach does not require stablecoins or two-sided liquidity provisioning.
- Volatility-Based Yield: Higher ARB volatility translates into higher option premiums, benefiting the treasury. Unlike lending yields (which depend on borrowing demand) or DEX fees (which require stimulating trading volume), covered call yield is purely volatility-driven.
- Immediate Stablecoin Income: Yield is generated upfront and paid in stablecoins, without fluctuating APYs.
- Retaining ARB Upside: ARB exposure is maintained up to the strike price, which can be tailored to community preferences. No ARB is sold at current prices.
- Capital Efficiency: ARB is fully utilized without idle capital, unlike lending markets where utilization rates are typically below 100%.
- On-Chain Execution: The strategy can be executed permissionlessly on-chain, settled natively on Arbitrum, without counterparty risk.
Given these benefits, we believe covered calls can help the Arbitrum treasury put otherwise idle ARB to work, generating stablecoin yield for the DAO while also introducing and showcasing on-chain structured products within the Arbitrum ecosystem through the MYSO v3 deployment on Arbitrum.
2) What Are Covered Calls and How Do They Work?
A covered call strategy involves holding an underlying token (ARB) while selling call options against it, generating upfront stablecoin income. The stablecoin income comes from trading firms bidding to acquire call options to engage in “gamma scalping”, capitalizing on price volatility in a market-neutral way.
A call option grants the buyer the right (but not the obligation) to purchase the underlying (=ARB) at a predetermined strike price (e.g., 1.2x the current price) within a set duration (e.g., 30 days). By selling this right, the DAO receives an upfront option premium.
Example:
- Notional: 5M ARB (~$2.25M)
- Strike Price: 130% of spot (~0.584)
- Duration: 30 days
- Indicative Option Premium: $60K USDC (~2.7% of notional, 32.8% APY)
Potential Outcomes:
- ARB Price ≤ 0.584 (Option Expires “Out-of-the-Money”) → Arbitrum retains the 5M ARB.
- ARB Price > 0.584 (Option Expires “In-the-Money”) → Arbitrum receives $2.92M USDC but does not get the ARB back.
One key point to highlight is that technically covered calls have less downside risk than holding ARB. For example, if ARB were to drop to zero, the DAO would still have received the premium, offering some downside protection compared to holding the token outright. The primary trade-off is the potential opportunity cost if ARB’s price rises above the strike price plus the premium.
3) Implementing a Covered Call Strategy for Arbitrum
To optimize yield generation while minimizing conversion risk, we propose setting strikes and expiries that balance:
- Maximum yield generation
- Minimal probability of options expiring in-the-money (to retain ARB upside)
- Shorter option durations (to enhance liquidity and minimize lock-ups)
Strike Selection and Expiry Optimization
We analyzed historical ARB return data to identify strike levels that would not have been exceeded in 95%, 90%, and 85% of historical cases. As expected, the results show that:
- Higher strike prices lead to a lower conversion probability
- Longer expiries require higher strike prices for the same probability
Given these strike prices, one can calculate indicative option premiums and the corresponding APYs that a covered call strategy would generate based on different strike and expiry combinations. The resulting indicative yields are illustrated in the plot below. For covered calls with expiries of up to 30 days (to optimize for liquidity), the annualized yields peak around the 23-day mark before leveling off. At this duration, the indicative yields are approximately 4% for low conversion probabilities, 13% for medium conversion probabilities, and 30% for higher conversion probabilities.
Using these strike levels, we can perform backtests by running covered call strategies across random starting points and comparing the results to a buy-and-hold strategy over the same backtesting period. Below is an illustrative example of executing such a strategy, starting in June 2024, with a 128% strike, 23-day duration, and a 0.8% premium.
The overall results are shown in the table below, comparing three covered call strategy variations on 5,000,000 ARB to a buy-and-hold approach over the same time period, which resulted in a final position value of $2.0M:
| Avg. Final Position | Max. final Position | Min. Final Position | Conversion Occurrence | |
|---|---|---|---|---|
| 148% strike, 23dte, 0.3% premium | $3.5M | $5.5M | $2.0M | 61.34% |
| 128% strike, 23dte, 0.8% premium | $3.4M | $5.4 | $2.0M | 78.20% |
| 116% strike, 23dte, 1.9% premium | $3.2M | $5.9 | $2.1M | 79.36% |
Note: Yields are indicative and may vary depending on ARB volatility and market conditions at the time of execution. However, we have already validated liquidity supply to match with trading firms for notional amounts of up to ~$5M, offering similar premiums and yields.
4) Addressing Risks and Mitigation Strategies
We appreciate the TMC highlighting key risks associated with the ARB strategy in the forum and outline below how these risks can be effectively managed:
1. Smart Contract Risk
The strategy will be executed on-chain using the MYSO v3 protocol, which has been audited by Omniscia. As an additional precaution, the DAO could start with a smaller notional amount or shorter durations to test the implementation before scaling up.
2. Asset Risk (ARB Losing All Value)
A key advantage of covered calls is that they provide some downside protection compared to simply holding ARB. For example, if ARB were to drop to zero, the treasury would still retain the upfront premium from selling the call options, making this approach superior to holding ARB outright.
3. Counterparty Risk (No Trading Firm Willing to Buy Calls, Yield = 0%)
We have already validated liquidity supply with trading firms for notional amounts of up to $5M, ensuring there is consistent demand for ARB call options. Furthermore, higher ARB volatility increases option premiums, meaning the yield generation mechanism is not reliant on external borrowing demand or trading volume stimulation (as seen with lending or AMM-based yield strategies). Instead, yield is sustainably generated from ARB volatility itself.
4. Liquidity Risk (ARB Locked for the Duration of the Call Option)
To minimize liquidity lock-up risks, we propose:
- Shorter tenors (e.g., 10-30 days) to enhance liquidity and allow frequent repricing.
- Strike price selection based on historical data to reduce conversion probability while maximizing yield.
- Potential early exit mechanisms via secondary market liquidity, allowing the treasury to unwind positions before expiry if necessary.
5. Potential Conversion Risk (ARB Converted to Stablecoins at Expiry)
If ARB surpasses the strike price, the DAO may miss out on additional upside. However, we mitigate this by:
- Setting strike prices that balance risk and yield, ensuring conversions (if they occur) happen at favorable price levels.
- Using historical ARB price data to determine strikes that minimize conversion risk while optimizing yield.
- Retaining ARB exposure up to the strike price, meaning the treasury benefits from price appreciation up to that level.
6. Premium Fluctuations (Volatility-Driven Yield Variability)
While option premiums fluctuate with ARB’s volatility, this can be advantageous for the treasury. Higher volatility leads to higher option premiums, directly increasing yield potential. Unlike lending markets, which depend on borrowing demand, covered calls generate yield independently—only volatility matters.
7. Secondary Market Risk (If Calls Are Closed Before Expiry)
If the DAO chooses to unwind a covered call early, there is exposure to secondary market pricing dynamics. However, even in the unlikely scenario where a trading firm demands an unfair premium to buy back the call and close the position, the DAO can simply wait until expiry. This means the DAO is not strictly dependent on the secondary market and can “sit things out” if needed, maintaining control over execution.
5) Operationalizing the Strategy
To execute the strategy, the following steps would be taken for each option-writing cycle:
- Define strike price and duration based on market conditions and DAO preferences.
- Obtain tradeable quotes from trading firms and publish results (anonymized).
- Schedule execution with the selected trading firm and the TMC/Arbitrum Foundation.
- Execute trade using an off-chain signed quote.
- Lock ARB collateral in a segregated MYSO v3 escrow contract while receiving the stablecoin premium.
- At expiry: Either (a) reclaim ARB if the option expires out-of-the-money or (b) receive the conversion amount in stablecoins.
- Report on execution: We will provide periodic updates on premium earnings and option performance.
We hope this additional context helps the Arbitrum Community make an informed decision regarding the proposed ARB-only covered call strategy. We look forward to engaging with the community and answering any further questions!