Pricing coupons as options

The current structure of coupons makes them very similar to vanilla call options for buyers however the current pricing formula does not consider the variables of such options and therefore overprices them. The result is a negative expected value bet for buyers once price deviates too far from the peg. This creates the risk of a death spiral.

When one buys coupons there is an expiration date (30 days), a strike price ($1) and volatility (the historical or future estimated volatility of $ESD).

The peak historical volatility is about 250%. Let’s double that to 500% (more volatility gives more option value). If you plug this into a Black Scholes calculator that gives a call option value of $0.18, currently we are getting 1.55 calls worth $0.28. The current ESD price of $0.50 now seems like a big premium to pay and that is after padding the volatility.

I propose the coupons be priced using Black-Scholes as it’s had decades of a track record in establishing itself as the theoretically correct way to price options. The debt/supply ratio can still be used to determine what the implied volatility is. As the ratio increases the IV will fall creating a larger probability of profit for buyers.

Are you accounting for how exercising the option is free? If I bought 1.55 call options with a strike price of $1 for $0.28, I would also have to pay $1.55 to exercise them if the strike price were hit, right? That’s definitely a negative return unless the price of what I’m optioning goes above $1.18.

With coupons, you have a positive overall return at the strike price.

Good point. If we lower the strike price by the amount of the premium that gives a strike of $0.82. The new calls would be priced at $0.21. It’s still a steep discount to the upfront cost today.

Once in the money no additional capital would be required using flash loans or a secondary market for coupons. If they are in the money you can:

  1. Take a flash loan in the amount of strike X number of coupons
  2. Exercise
  3. Sell at market price
  4. Pay back flash loan.