2️⃣The Straddle

A straddle is a neutral options tradFi strategy that involves simultaneously buying both a put option and a call option for the underlying security with the same strike price and the same expiration date.

Straddler Buyer

The straddle buyer pays the premiums of the options but he realizes his profit as the price of the underlying moves significantly in either direction. He is profitable when the difference between the underlying and strike is greater than the combined premiums he paid for both option contracts. This is therefore a long volatility position that is indifferent of market direction. As the volatility of the underlying asset increases, the higher the likelihood his position will turn positive.

Straddler Seller

A straddle seller is someone who sells a call and put option on the same underlying with the same strike price and expiration. His return profile is the opposite of that of the straddle buyer. Whereas the straddle buyer benefits as volatility goes, a straddle seller benefits when volatility decreases and the price of the underlying remains the same until expiration. The straddle seller’s profit is the premiums of the option he sold minus the exercisable value of the options at expiration, if one of them expires in the money. A straddle seller is short volatility.

LP provision as a Perpetual Short Straddle

As we established earlier, an Uniswap pool is at all times holding short put positions on its reserve assets. However, since both assets are priced in terms of the other asset, one of the short puts can also be thought of as a short call on the other asset.

If we wanted to represent a short straddle in terms of an Uniswap LP position, one could borrow both reserve assets and provide them as liquidity to the pool. In that case the requirement to first have both assets disappears, and the diminishment of one asset’s quantity does indeed represent a short position. In addition, an interest rate exposure is introduced since the borrowed funds will accrue interest and must therefore be subtracted from the yield from trading fees.

Therefore, an Uniswap LP provision position is nothing more than a short straddle with the characteristics of it being perpetual (no time $\tau$ risk), variable continuous premium from trading fees, and sold with strike prices equal to the current market price. In other words, a swap of volatility or gamma risk for a perpetual stream of payments from trading fees.