Liquidations

Link to code: https://github.com/IVX-FI/ivx-diem/blob/759836ea5fed1951d9ee88514e84c1d4e092411f/src/options/IVXDiem.sol#L280

Example: A Single Call Option

Consider a scenario where Alice wants to buy a call option C which is priced at $30. Alice has available in her margin account $15 for the purchase of this option. In order to facilitate purchase of the option, the Diem pool agrees to loan Alice the additional $15 she requires to purchase the option:

At the end of this process, Alice has a portfolio which consists of one call option C and a loan of $15 which needs to be repaid. That is, the equity balance of her margin account is given by

where the −15 represents the amount owed to Diem and C the instantaneous liquidation value of the call option.

Over time, Alice will accrue interest on her borrowed funds which she owes to the Diem pool, in addition to this, the price of the option C will also change. At a given time t in the future, the equity balance of her margin account is given by

If the equity value Mt falls below a liquidation threshold, Alice’s margin account will be up for liquidation, meaning an external liquidator will be eligible to force close Alice’s positions, pay back her debts and return to Alice the residual collateral minus a liquidation fee f:

The reason this system works at the end is that the Diem system operates on a notion of “effective” margin rather than exact margin, since each margin constituent is down-weighted by a collateral factor we ensure that there is sufficient headroom to afford the fee f and ensure solvency at the point of liquidation.