Liquidations

Accounts can be margin called and liquidated.

Maintenance Margin Requirement

For options that have been minted out-the-money (OTM), the buying power requirement is simply given by the sell and buy collateral ratio. As the price evolves and an option becomes in-the-money, risks may increase, and the deposited amount of collateral may need to increase to mitigate those risks.

For example, selling an OTM put option initially requires 20% collateralization. As the price decreases below the strike price, the buying power requirement will increase above 20%. The exact buying power requirement for a short put at strike $\mathtt{K}$ when the current price is $\mathtt{S}$ and an initial collateral ratio of $\mathtt{C_i}$ is given by:

$$\mathtt{Buying\ Power\ Requirement = notionalSize \cdot \left(100\% - (100\% - C_i)\cdot\frac{S}{K}\right)}$$

In contrast, the in-the-money amount (or the amount of funds necessary to cover the option) is always lower than the buying power requirement, and it is defined as $\mathtt{ITM\ amount = notionalSize \cdot\left(100\% - \frac{S}{K} \right)}$. So, selling a 1000 ETH-USDC put will start with a buying power requirement of 200 USDC when the price is above 1000 but will increase to 500 USDC if the price decreases to 625, whereas the ITM amount will be 375.

Short Put Buying Power Requirement

The buying power requirement of a short put is limited by the notional value of the option.

              Short put BPR = 100% - (100% - SCR)*(price/strike)
BUYING        
_POWER                       
_REQUIREMENT  ^                    .
              |           <- ITM   .  OTM ->
       100% - |--__                .         
              |    ¯¯--__          .
              |          ¯¯--__    .     
        SCR - |                ¯¯--______ 
              |                    .
              +--------------------+--->   current
              0                  strike     price

Short Call Buying Power Requirement

The buying power requirement of a short call can exceed the notional value of the minted option.

              Short call BPR = SCR + (100% - SCR)*(price/strike - 1) 
BUYING                                           
_POWER           <- OTM  .  ITM ->            _-¯
_REQUIREMENT  ^          .                 _-¯
              |          .              _-¯
       100% - | -   -   -. -   -   - _-¯  -  - 100%
              |          .        _-¯  .
              |          .     _-¯     .   
              |          .  _-¯        . 
 SELL_RATIO _ |___________-¯           .
              |          .             .
              +----------+-------------+--------> current
              0         strike       2 * strike    price

However, users can deposit the asset as collateral in order to mitigate those risks. In this case, the Buying Power Requirement for short calls (with 100% of the collateral denominated in the asset) is:

BUYING         Short call BPR (covered) = 100% - (100% - SCR)*(strike/price) 
_POWER                   .
_REQUIREMENT     <- OTM  .  ITM ->
              ^          .                        100%
       100% - |  -   -   . -   -   -   -   - _____------ 
              |          .      ___----¯¯¯¯¯¯
              |          .  _-¯¯
              | min BRP  . -     
 SELL_RATIO _ |___________¯
              |          .
              +----------+----------------------> current
              0         strike                     price

Account Liquidations

To determine whether an account is solvent, the Panoptic protocol computes and adds up the collateral requirement for each position. The protocol will then compare the amount of user-deposited collateral with the account's total collateral requirement.

Because users can deposit both types of tokens for a token pair to be cross-collateralized, it is the actual value of the required collateral and of the collateral balance that are compared. Based on this calculation, an account can be liquidated if Total value of collateral < collateral requirement

Liquidation Bonus

The liquidation bonus for liquidating an account is determined by two factors:
i) The distance between the strike and the current price
ii) The in-the-money amount

It is worth revisiting the figure shown in the Margin page, where the size of the bonus and the amount of loss incurred by the protocol is highlighted.

A few key points from the liquidation process:

1. The liquidatee's collateral is used to exercise the in-the-money options and pay the liquidator
2. The bonus to the liquidator will be equal to zero if the price falls below strike - CollateralRequirement
3. The bonus will stay at zero as the price decreases further.
4. The liquidator will be compensated by the protocol loss and will be rewarded by not losing anything (as opposed to the rest of the Panoptic Liquidity Providers who will share that loss amongst themselves)

The goal of the liquidation system is to incentivize Panoptic Liquidity Providers to be liquidators as well, since a healthy liquidation system means the pool will never incur a loss.