Risks with Perpetual Options

As we learned from our previous article on perpetual options, perpetual futures and perpetual options are extremely similar. The only real addition of the perpetual option is the introduction of a Strike Price. The Strike Price changes the payoff function of the perpetual future, enabling it to have a non-linear payoff. This non-linearity enables it to express an arbitrary amount of payoff functions. Traders are no longer limited to just two payoff functions, as is the case with the standard version of the perpetual future.

Risks With Perpetual Options

Trading the perpetual option exposes traders not only to delta risk, but also to gamma and vega risk. Traders will have to manage a complex set of greeks (delta, gamma, vega) instead of just delta. The non-linear payoff function enables them to profit from changes in volatility.

Holders of perpetual options can be subject to liquidation, if they are unable to pay the hourly funding fee. However, perpetual options cannot be bought on leverage, making liquidation less likely relative to leveraged perpetual futures trading.

The risk of perpetual options trading depends highly on the strategy used. Since there are literally hundreds of different perpetual options strategies (ranging from short straddle to long box spread), it is not possible to make a definitive statement on whether perpetual options trading is more risky than perpetual futures trading.

Perpetual Options and Funding

Perpetual options have much higher funding rates than perpetual futures. The funding rate is the percentage amount that longs pay to shorts every hour. If it's negative, shorts pay longs. Both scenarios (longs paying shorts and shorts paying longs) can happen with perpetual options, and the amount being exchanged (the percentage rate) is often much higher than for perpetual futures.

While perpetual futures traders can often completely ignore the funding rate (due to it having negligible impact on their P/L), it simply cannot be ignored when trading perpetual options. Perpetual options traders must take the funding rate into account at all times, as it is often what makes or breaks a strategy.

Conclusion

The perpetual option is best suited for traders that want exposure not only to price, but also to volatility.

Buying a perpetual put option can often be superior to shorting a perpetual futures contract, since the former enables the trader to benefit from positive convexity. Perpetual put options have a potentially unlimited upside, while the upside of a perpetual futures contract is capped to 100% of the position size.

This fact expresses itself in a generally higher funding rate (perpetual options on Everstrike can have hourly funding rates as high as 10%). As with perpetual futures, the funding rate can be earned by anyone who is willing to short the contract. Short-selling perpetual put options with high funding rates can be a very profitable, but also risky strategy, since you earn a funding of up to 10% of your position size per hour, but also expose yourself to immense risk, should the price of the contract's underlying asset crash, and render your shorted put option extremely valuable.

In general, the perpetual option opens up a whole new array of trading strategies, not possible with the perpetual future. For example, you can be short volatility, and earn funding, or you can be long volatility and long delta, and earn a potential reward on upswings that is much superior to that of the perpetual future.