Trading Volatility Without Guessing Price Movements: What New Strategies Does Paragon's Power Perps Bring?

Author: 0xFacai, Blockbeats

As we mentioned before, in September, the on-chain options nominal trading volume reached $4.829 billion, a month-on-month increase of 121.7%; the monthly premium trading volume also grew from over $20 million at the beginning of the year to over $80 million. Jeff, the founder of Hyperliquid, publicly discussed the development opportunities for options.

However, many crypto-native traders have long been accustomed to the operation of perpetual contracts. If they are bullish, they go long; if they are bearish, they go short, putting in margin and opening or closing positions at any time. When switching to the options interface, facing rows of strike prices, expiration dates, and Greek letters, the impulse to trade is first consumed by the complexity of the operations.

The newly announced Power Perps by the HIP-3 trading platform Paragon provides another entry point. It starts from HYPE², allowing traders to gain options-like profit curves by "opening contracts."

There are no strike prices and no expiration dates. You are still trading a perpetual contract, but the price it tracks has become the square of HYPE.

Convexity

The profit of a regular perpetual contract is a straight line. Holding a fixed number of long positions, for every $1 increase in the underlying, the profit remains the same; for every $1 decrease, the loss is also the same. Leverage will make this straight line steeper, but the shape remains unchanged.

The "Nth Power Contract" changes this.

For the sake of convenience, let's assume an asset starts at a price of $100, and the price of the second power contract also starts at 100.

If the underlying rises to 110, the index reaches 121, an increase of 21%; if the underlying falls to 90, the index drops to 81, a decrease of 19%. With the same 10% price change, the long position earns a bit more when the price rises and loses a bit less when it falls.

Expanding the price range makes the difference even more apparent. If the underlying rises by 50%, the second power index rises by 125%; if the underlying falls by 50%, the index falls by 75%. If the underlying doubles, the index becomes four times its original value. The third power contract takes it further; if the underlying doubles, the index becomes eight times its original value.

Assuming the underlying's price change is r:

The price change of the second power contract = 2r + r² Profit curve of the second power contract compared to a 2x regular long position

The front part, 2r, provides the profit margin of a 2x leveraged long position; the latter part, r², is always non-negative regardless of whether it rises or falls, thus relative to 2x long, it can increase profits when the price rises and reduce losses when it falls. Moreover, the larger the price movement, the greater this difference becomes.

This is "convexity." Moving up along the second power curve, for every additional $1 increase, the long position earns more than the previous $1; moving down, for every additional $1 decrease, the loss is less than the previous $1. The sensitivity of the second power contract changes automatically with the price, which is something regular contracts cannot achieve.

What options traders are willing to buy includes this kind of "convexity."

This concept had a theoretical basis as early as 2021. Paradigm's Everlasting Options discussed how to maintain "never-expiring" options exposure with continuous funding fees, and subsequent articles on Power Perpetuals took the power of the price as the tracking target. Opyn later practiced this with Squeeth, which tracks ETH², and Paragon aims to bring such products to the Hyperliquid order book.

In addition, the trading demand for traditional options is scattered across many contracts with different strike prices and expiration dates, resulting in fragmented liquidity. The "Nth Power Contract" allows traders of the same underlying and the same power to share a single order book.

Rates

At this point, it’s easy to have a thought. The second power contract rises faster and falls slower; where is the cost of this benefit?

Let’s conduct a long-short experiment. Suppose a trader opens a second power long position when the price is 100 and hedges with a linear short position of two units of the underlying asset. If the underlying price rises from 100 to 110, the second power long earns 21, while the linear short loses 20, totaling a profit of 1. If the underlying falls from 100 to 90, the second power long loses 19, while the linear short earns 20, still totaling a profit of 1. If it rises to 120 or falls to 80, both scenarios yield a profit of 4.

Expressed in formula, the profit and loss of this long-short combination is:

Long-short combination price profit and loss = (Price difference of the underlying asset from 100)² ÷ 100 Profit and loss of the second power long position and linear short position combination

If there are no funding rates, traders could arbitrage for free through the above method.

However, the "no-arbitrage principle" requires that such benefits must have a price, i.e., funding rates.

From the perspective of market makers, it becomes easier to understand. Market makers sell a second power contract while buying two units of the underlying asset for hedging. If the underlying rises by $10, the market maker's short position loses 21, while the hedged spot only earns 20, resulting in a net loss of 1; if the underlying falls by $10, the short earns 19, while the hedged spot loses 20, also resulting in a net loss of 1. This is the "arbitrage" profit on the other side.

Market makers also need to adjust the hedged quantity as prices change. After each adjustment, the next price movement will generate profits and losses related to the square of the price change. Accumulating these squares gives us the "variance" here. The more volatile the price movements, the higher the hedging costs that market makers incur to provide convexity.

Therefore, in addition to the holding costs of regular contracts, the longs of Nth power contracts also need to continuously pay for convexity. This part of the cost is related to variance (the square of volatility), usually paid by longs to shorts. The bid-ask spread will also affect the final funding rate.

Liquidation

Starting again from $100, let’s compare a 2x long position with a fully collateralized second power long position worth $100.

If the underlying falls from 100 to 50, the loss of the 2x long position is $100, and the principal is already lost, with actual liquidation occurring even earlier. Ignoring funding rates and other full-position losses, the second power long position would still retain $25 in equity when it falls from 100 to 25, and would not be liquidated solely due to the price drop.

The fully collateralized second power long position allows traders to gain about twice the initial price sensitivity while avoiding liquidation triggered solely by price drops.

However, if leverage is added to the second power contract, liquidation will approach quickly. According to Paragon's risk documentation example, not accounting for accumulated funding fees and other account assets, a 2x HYPE² long position will be liquidated when HYPE drops by about 22.5%, while a 3x HYPE² long position only needs to drop by about 10.6% to be liquidated. Liquidation differences

The short side must also be more cautious. The higher the price rises, the faster the losses of the second power short position accumulate, and a 1x second power short position will also be liquidated.

Volatility Trading

The earlier combination of the second power long position with a linear short position can also become a trading strategy. You don’t have to judge whether the price will rise or fall next; you only need to determine whether the price will move far enough from its current position.

In traditional options, buying call and put options with the same strike price and expiration date can form a "straddle." The call option profits during a big rise, while the put option profits during a big drop, providing profit opportunities in both directions. Power Perps can also create a profit curve that rises on both sides by pairing a second power long position with a linear short position. Profit curve for going long and short on volatility

This is an intuitive entry for going long on volatility. Both big rises and big drops can present opportunities, but the price needs to have sufficient volatility to offset the funding costs.

Conversely, shorting the second power contract and buying a corresponding amount of the underlying asset or linear long position for hedging allows you to short volatility. If the price stays close to the opening position, the funding fees collected from the second power short contract can become profits; however, once there is a big rise or drop, the losses after hedging will increase with the square of the price movement.

However, the characteristic of the second power contract being "without an expiration date" also means that the funding fees, this holding cost, can accumulate indefinitely.

Power Perps cannot replicate all traditional options strategies exactly. A straddle requires two different strike prices; spread strategies can set profit caps and loss floors through different strike prices; covered calls and puts also require selling options at specified strike prices, giving up part of the profit space in exchange for premiums.

These strategies all have profit inflection points defined by strike prices, usually also stipulating expiration times. The second power contract paired with linear positions yields a smooth curve. Adjusting the position ratios can approximate some options strategies within a certain price range; however, to precisely stipulate "capping at a certain price" or "maintaining profits within a certain range," options are still necessary.

The cost of simplifying operations and concentrating liquidity is the loss of some freely selectable profit structures.

Evolution of the "Token Listing" Strategy

Hyperliquid provides the order book, underlying market, and margin system, while Paragon designs new profit curves based on these foundations. Market makers can hedge more conveniently, and developers can continue to package combinations into strategies, reducing the operations traders need to perform for building and adjusting positions.

Traditional options have already proven that there is a long-term demand in the market for different profit structures. The value of Paragon's attempt this time lies in expressing part of that demand in a way familiar to crypto-native traders, and allowing existing perpetual liquidity to provide hedging for new products.

A more noteworthy trend is that the "token listing" on the HIP-3 exchange has evolved from selecting popular traditional financial assets to creating new forms of derivatives. We look forward to seeing more such financial experiments on Hyperliquid.

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