AMM Design

What is Diem

Diem is an Automated Market Maker (AMM) that's designed to facilitate permissionless short-term options trading with a timeframe of less than 24 hours, also known as 0DTE markets.

Notably, it acts as a singular pool that offers options on various underlying assets, all collateralized by this pool. Diem settles the first step toward unifying option liquidity into a unified collateral pool for multiple assets and strike prices, enhancing the user experience, creating a feasible architecture for liquidity providers and wider liquidity for options traders. This lays the foundation for expanding the IVX AMM to support a diverse range of expiry times.

How Diem Operates

The Diem AMM serves as the counterparty for all users interacting with the IVX protocol. If a certain user seeks to purchase an option on a specific strike price, the AMM automatically accepts the trade, exposing itself to a one-sell option contract of the same asset on that same strike price. If a user wishes to close the bought option, the AMM's exposure as a seller will be removed, leading the AMM to exercise the option following the American options methodology.

The AMM allows any time entry and exit for traders, settling options contracts' profits with $USDC as the native pay-off asset. During the trading session, the AMM will have specific market exposure calculated by knowing the opposite of the net total option positions opened for each asset executed on the AMM. The AMM exposure can be monitored by aggregating the net Delta and the net Vega across all positions, and based on this data, the AMM will adjust perpetual positions to reduce market exposure.

The AMM operates uniformly across all assets, which means the AMM will be able to concentrate on offering larger liquidity based on the most asked token to be traded by users, while at the same time providing a friendly user experience for liquidity providers who seek a deposit-and-forget capability, without concerns about liquidity rebalancing between tokens or transferring LP assets between epochs.

Generation of Options Contracts

Every day at 8:00 AM UTC, the Diem AMM generates option contracts for supported assets with associated volatility sources, initiating the trading session and allowing traders to write or purchase option positions that expire at 8:00 AM UTC the following day. During the 24 hours, (excluding 30 minutes before expiry when trading will be stopped), traders are allowed to enter or exit from any position based on a pre-generated list of strike prices that depend on each asset. In standard cases, the AMM will offer either:

  • A single strike price for high-volatile assets

  • A list of three strike prices for mid-volatile assets

  • A list of five strike prices for established high market-cap assets

The strike price list is either pre-defined by the Oracle bot, or fetched from an off-chain source, dynamically updating with each percentage change in the spot price, aiming to be centered around this price.

AMM Cap Limit

The liquidity provided to the Diem AMM is divided into three sub-pools:

  • 50% of deposited assets are used for writing or purchasing option positions from users, where the AMM will be limited to the total maintenance margin required across all tokens (If the AMM has a seller and a buyer on the same token and the same strike, the AMM will have zero exposure to this option).

  • 40% of deposited assets are used for delta-hedging dynamically across external perpetual markets. The position leverage will range between 1.25x to 2.5x depending on the asset's volatility.

  • 10% of deposited assets will be reserved outside of the AMM accounting to cover deficits in the hedging sub-pool or the collateral sub-pool.

Suppose an option position could jeopardize the AMM's collateralization ratio or hedging percentage. In that case, the position will be reverted. In future versions, the Diem AMM will have native asset rebalancing between sub-pools, to ensure higher capital efficiency for traders and liquidity providers.

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