This document provides a comprehensive technical overview of the Options Portfolio Auction mechanism in portfolio liquidation scenarios, detailing its architecture, execution methodology, and strategic advantages for both participants and market operators.
The mechanism is designed to facilitate the efficient liquidation of distressed portfolios while maintaining market stability and ensuring fair asset valuation. By leveraging automated bidding and risk management strategies, the system allows market participants to engage in transparent and competitive auctions.
Why a Portfolio Auction Mechanism?
Traditional liquidation methods rely on order book execution, position assignment systems (PAS), and unwinding. However, these methods pose challenges when dealing with complex portfolios, especially those involving options. The bid-ask spread in options markets can be large, making it difficult to execute liquidations efficiently.
To address these challenges, we introduced a portfolio auctioning mechanism that allows other users to place offers on a bankrupt user's portfolio, ensuring better price discovery, liquidity, and risk transfer. This auction system provides a structured alternative to direct order book liquidation, making the process more effective for complex portfolios.
Auction Process
Every portfolio containing options is split in two:
- Futures with underlying anything other than BTC and ETH.
- The rest i.e. Futures with BTC, ETH as underlying and the options
Part A goes through the equity protection process. Part B goes through the auction process. Therefore, the auction process described below concerns only the sub-portfolio B.
1. Step Zero
Before initiating the full auction process, the system follows Step Zero, an initial strategy aimed at reducing complexity in auctioned portfolios.
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Liquidating Standalone Futures Positions:
Any futures holdings in a currency pair in which they do not also have an options position (and therefore do not hedge options exposure) are liquidated using standard order book execution. -
Converting Non-USD Balances:
To streamline the auction process, all non-USD balances are converted into USD, ensuring uniformity in valuation and settlement. And having to no longer consider haircuts when valuing margin, which should give more (effective) margin to work with during the liquidation.
By executing these preliminary steps, the auction system ensures a smoother and more efficient bidding process while mitigating unnecessary risks.
2. Splitting Large Portfolios
Large portfolios are split into multiple auctions, as no single user may want to bid on the entire portfolio, but many users may be willing to bid on smaller parts.
We will define two thresholds, based on notional value and maintenance margin required.
For example:
- BTC notional threshold: 200 BTC
- ETH notional threshold: 3000 ETH
- MM requirement threshold: 100k USD
Before auctioning, a portfolio should be compared to these thresholds, and if it exceeds either it should be split. The split should be into equal parts, and the divisor will be the maximum ratio of the portfolio to the thresholds.
For example:
- portfolio has 500 BTC notional, 1200 ETH notional and 150k USD MM requirement
- ratios are:
- BTC notional: 500 / 200 = 2.5, exceeds threshold
- ETH notional: 1200 / 3000 = 0.4, does not exceed threshold
- MM requirement: 150k / 100k = 1.5, exceeds threshold
- we take the maximum ratio of 2.5, and split the positions in the portfolio by that amount
- e.g. a 1000 contract long position becomes 400, 400, 200 between three smaller portfolios
We don't add any information related to the auctions itself to the Unwind output event, instead each auction will have a reference to the unwind event that generated them.
3. Auction Round
- Auction Initialisation: Once a portfolio goes into auction the portfolio with all the positions when that auction loop ends would be shown.
- Sealed-Offer Auction: Users then have x (e.g. 10) seconds to offer a price for it in a hidden auction, whoever offers the most keeps it. Note that the amount offered can be negative (whoever wins would get immediate uPnL to keep the portfolio).
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Descending Price Auction: If no acceptable offers are received, the system lowers the internal minimum offer requirement progressively in subsequent rounds until someone places an adequate offer on it or until the maximum amount of iterations has been reached.
Example:
A portfolio that has a mark price of $100
First loop: we are willing to accept an offer $50 away from the mark price
Second loop: we are willing to accept an offer $100 away from the mark price - Unwind: After a few (e.g. 5) iterations unwind the portfolio by reducing open interest, similar to how it’s already done in futures
Funding Rate Considerations: If perpetual positions remain in the auctioned portfolio, funding fees are not paid by the auction winner.