How binary options work
Binary options are a type of options contract that provides a fixed return based on a binary outcome in the future. They pay out on a certain date if the price of a chosen asset is above (or below) a level specified at the creation of the option.
This post will explain how this new feature works and how to get involved.
Binary options explained
A binary option is a contract that allows someone to make a trade on a yes/no outcome. For example, a market could be created on the following statement:
BTC will be above 10k USD on 31st December 2020.
This statement will be either true or false. True is represented by “long” options and false is represented by “short” options. In “parimutuel” binary options — the kind that Synthetix uses — the each side of the market pays out the other side.
For example, if the “BTC over 10k” market attracted a total of 10,000 sUSD, where 33% of bidders went short, and the long side is correct, the long side splits the 3,333 sUSD from the short side. In this case, this market determined that there was a 67% probability that BTC would be above 10k on December 31, 2020, and therefore long bidders received 3,333 sUSD for the 6,667 sUSD they supplied. All binary options markets are denominated in sUSD, and that is the only currency used to purchase options.
Binary options use a floating auction mechanism, which means the price of each side is in flux until the Bidding phase is over. In other words, the state of the long and short skew at the time you make a bid does not affect what the payout will be when the market is resolved. What is relevant to the eventual payout is the long and short skew when the Bidding phase is over, and of course whether the binary option is true or false.
When you make a bid and purchase an option, you are putting your sUSD into the total pool of funds, and choosing a side. To illustrate, let’s use the previous example of “BTC over 10k,” with a total of 6,667 sUSD long and 3,333 sUSD short when the Bidding phase ends. If BTC is over 10k the long side of the market is successful, and shares the 3,333 sUSD from the short side, i.e. $2 of long options receives $3.
In summary, when bidding, users will not know how the market will eventually settle as they will only be able to view the current size of each side. Users should monitor the skew throughout the Bidding phase to ensure it continues to reflect the probability they assign to the outcome.
Binary options support markets for all the non-inverse Synths in the Synthetix ecosystem, as well as SNX. Here is the full list of assets supported:
Bidding on open markets
To get started, head to Synthetix.Exchange and in the “Options” tab you can view all the current open markets. You can join options markets that have already been created. This page displays how much time is remaining in each market’s current phase. The “strike price” this page refers to is the price prediction for each market, e.g. the market for “BTC over 10k” has a strike price of 10,000.
There are three phases an options market can be in: Bidding, Trading, or Maturity.
The Bidding phase
This phase allows you to place a long or short bid in a floating auction. The current “Market Sentiment” for that market (i.e. the current spread of long/short bids) determines the price of making a new bid and the eventual payout, though these will continue to shift as Market Sentiment shifts.
During the Bidding phase it is possible to withdraw a bid, but there is a 5% fee to do so. You can make as many bids on either side from the same wallet as you like.
The Trading phase
At the start of the Trading phase, the current options are fixed and the spread of long/short bids will determine the payouts for each side should it win. Bidders on either side are issued ERC-20 tokens representing their options, which they can claim. If you claim these tokens, they can be traded OTC or via AMM markets.
If you don’t wish to trade or move them, you do not need to claim these tokens.
The Maturity phase
The Maturity phase represents the time after the option has matured, e.g. for the example market “BTC > 10k on 31st December 2020,” the Maturity is 31st December 2020.
Once a market has reached the Maturity phase, you can “exercise” your in the money options if you have any.
The Maturity phase only lasts for six months (this is configurable by submitting an SCCP) — this means that any options must be exercised before the expiry date or they will be lost. The current plan for any unclaimed sUSD is that it will be awarded to whoever closes an expired market (there is currently no UI for closing markets).
This feature is not yet live, but you will soon be able to view all of your options in any phase on the Assets page, (except for options you have already exercised).
Creating a market
To create a market, on the Options page of Synthetix.Exchange there’s a large “Create A New Market” option. It takes you to a page where you can select an asset, a strike price, the relevant dates, and the long/short price skew. The long/short price skew is the market creator’s expected probability (i.e. their initial belief about the odds). This determines the initial price of each option, though this will shift once people start purchasing options on either side. The maximum skew possible at market creation is 95% to 5% on either side. By choosing an opening price skew, the market creator has options on either side, as if they set an 80% long and 20% short opening price skew, their options are 80% long and 20% short.
There is a minimum amount required to create a market. To begin with, this is 1000 sUSD, though this is configurable by SCCP. The market creator cannot withdraw until there is sufficient liquidity.
Apart from the mentioned 5% fee for withdrawing a bid, there are two kinds of fees. Together, they add up to 1% of the total market volume, and are paid out when a market reaches the Maturity phase. 0.2% goes to the market creator, and 0.8% goes to SNX stakers (i.e. to the feePool) to be claimed in that fee period. The size of the fees paid to the market creator and the SNX feePool is not affected by which option is successful — it’s a proportion of the total bids.
This is the first trading feature that is always net-positive for SNX stakers — they receive fees for enabling this feature, and don’t take on debt risk as they do with the spot market Synths.
Markets at launch
At launch market creation will be open to any sUSD holder. The Synthetix grantsDAO will fund 5,000 SNX to go to the community’s favourite market created in the first two weeks as determined via governance poll.
Come join us in Discord if you have any feedback or questions!