One of my favorite plays in Solana HODL is contributing to the network’s security by backing validators through Marinade Finance. Unlike typical staking, your funds are liquid, and you can withdraw them at any point (albeit for a fee if removed before the epoch). Anyone buying and holding Solana would want an appreciable place to put their funds to start earning some return instead of just riding the market.
When you stake Solana through Marinade, you get an mSOL token of equivalent value in return. Why do you get a different amount of mSOL tokens back if it’s the same value as SOL? That’s due to its yield (currently about 6% APY) distributed each epoch. Whenever a yield is distributed, the value of the mSOL token goes up an equivalent amount. This means when Marinade launched and was within its first epoch, the value was precisely 1:1 with SOL. I deposit one SOL and get one mSOL in return.
Friktion.fi provides another yield layer for all those mSOL tokens you’re holding. In addition to the 6% APY through Marinade, you can submit your tokens to Friktion vaults to do covered calls and get an average (at the time of writing) of 78.5% APY. Funds are locked up for a week and applied to covered calls. At the end of the week, you can withdraw your funds with yield (minus a 10% performance fee which funds Firktion.fi to continue operating).
Do I get yield plus the mSOL appreciation?
Yes! mSOL continues to appreciate at 6% while your investment is out making yield.
What are covered calls?
Friktion has launched with a covered call strategy and plans on offering additional investment strategies in the future. Their documentation details what a covered call is. In general terms, it’s an option placed on the market where you state you’d be willing to sell an underlying asset (in our case, mSOL) for a specific price (called the strike price) by a certain date (the expiry).
Should the market rise or exceed the strike price on the date of expiry (this is called “in the money” or “ITM”), the call is exercised. Your asset will be liquidated for the strike price (see below on what happens if your investment goes in the money).
Should the market stay below the strike price at the date of expiry, it is considered out of the money (OTM). OTM is the desired situation as your asset is returned to you, plus the premium the investor made to have the option to your covered call.
Who would want to create a covered call?
You would want to create a covered call if you felt the underlying asset market volatility would be neutral (or pessimistic) for a given date range. You will also want to do a covered call if you plan on holding an asset for an extended amount of time so that it does not sit idly and will be in a position to generate some of a return outside the market fluctuation. Seeing as your asset gets locked up for the investment term (Friktion does week-long calls), you would not want to put an amount up that needs to be liquid.
Who would want to buy a covered call?
Friktion conducts an RFQ-style auction with top crypto options Market Makers placing bids on-chain (called Channel RFQ). Channel RFQ was built by the Friktion.fi team and it runs a native order book powered by Serum. They utilize a variety of settlement platforms like PsyOptions and Inertia. Buyers are paying a premium when buying the covered call to access this investment vehicle. Buyers of covered calls are betting on the strike price being exceeded upon the expiry, which would allow them access to purchase the underlying asset at a discounted value compared to the market.
What is the risk of a covered call?
The perceived risk of a covered call is the market exceeding your strike price at expiry. If this happens, your underlying asset will be sold for the amount you agreed to, but without the additional upside the parabolic rise in the market may provide. Since the timeframes for covered calls on Friktion are so short and the team from Friktion are experienced market investors, they believe this will not happen often. Even if it does happen, I would make the case that it is not a risk – you are saying you are comfortable selling your asset at that price at the time of writing the covered call. The strike price should exceed the money you have in the asset. You also are getting a premium on top of the strike price in order for the investor to have access to the discounted rate. All in all, you should come out positive.
What happens to my investment if it’s in the money on expiry?
If your call is in the money on expiry, the buyer of the call will exercise acquiring the underlying asset at the agreed-upon strike price. In the instance of Friktion, this is purchased with USDC or similar. Friktion then has a rebalancer program on the blockchain to take whatever coin was used to purchase the asset and rebalance it back with limited slippage into the same token utilized in the underlying asset. You will receive back the equivalent token to the strike price times your initial investment (which will be likely fewer tokens than you put in, but with the increase in the market, it will likely be a fairly equal value).
What happens to my investment if it’s out of the money on expiry?
If your call is expired out of the money (meaning its strike price has not been exceeded), you get your invested asset back plus the premium the buyer paid for access to your option. This is the preferred outcome to investing in covered calls.
How do I determine strike price and date range on Friktion.fi?
The strike price is determined by the group running Friktion.fi (they call themselves Inductors [get it? Volts <> Inductors <> Circuits]). You do not need to decide your strike price. The Friktion team has promised a published research article on optimal call and put overwriting strike selection. When that is published, I will be sure to cover it here! For now, their summary is that they can do 10-20 delta calls with a 90% confidence interval.
As an informed investor, you would want to know the strike price before investing to see if you agree or not / to see if it fits your investment strategy. Currently, Friktion does not provide the strike price until your funds are locked and applied to the epoch (meaning the covered call is already written, executed, and sold).
Friktion does week-long epochs, so your covered call will last that long. If you want more control of your call option, you will want to write your calls directly on the PsyOptions platform. This type of analysis is what you are paying Friktion for (in the way of Performance Fees).
Are there alternatives to Friktion.fi?
Friktion currently boasts the best projected APY, even after considering Performance Fees (currently 10% of gains). However, one other popular platform is Katana.
Where can I find more information on covered calls?
If you want to read more, I’d recommend the article Friktion published titled “How do Covered Calls work?”