Volatility Update, 8/18/23

Everybody out of the water!!! The markets have awakened from their summer doldrums. Weeks of apathy and a lack of volatility finally gave way yesterday and into the night session, resulting in a 10% decline on the week. The markets opened lower Thursday, and the selloff picked up steam after the release of the Fed minutes showed rates will remain “higher for longer.” Risk off seemed to be the theme, as most asset classes witnessed significant selloffs from equites to commodities to cryptocurrencies. It appeared BTC and ETH might hold the $28,000 and $1,800 levels late yesterday afternoon, but capitulation arrived while many were on their commutes home. The markets dropped 7% in mere minutes as a string of long liquidations sent spot reeling, with BTC breaking below 25k and ETH breaking below 1500. Rumors that the SEC may greenlight the ETH Futures ETF resulted in a quick recovery of 4%. Prior to the selloff, much of the paper had been bullish in nature, possibly some anticipating this decision or a Gryascale Trust positive outcome. Regardless, the market remains at 2-month lows after liquidations of ~1 billion in the past 24 hours. As expected, just two days after reaching historic lows in Implied Volatility, these levels popped on the move, with the front-end trading as high as 65% last night. These levels have stabilized but still remain up significantly WoW.

Market moves such as this serve as a reminder of the importance of hedging, particularly during periods of low volatility. When realized volatility is low, implied volatility follows suit and brings down the cost of “insurance,” meaning protection via options. BitOoda has been recommending long IV strategies and downside protective structures throughout this low volatility cycle. In this report, we will revisit some of these strategies and highlight the benefit of hedging and how it can serve to offset losses during a downturn in the markets.

Hedging BTC – Successful Strategies for Miners

• We recommended hedging strategies last week to protect against a BTC price decline. In a low volatility environment, hedging is a cheap and effective way to buy “insurance” and offset potential losses from a market downturn.
• With Implied Volatility at historic lows, our main recommendation was a Protective Put Hedge struck at $26,000 in the September contract. The strategy required an outlay of $425/lot.
• With the market down 10%, the puts have increased to a price of $1350 – a gain of 215%. The costless collar is now worth $1200.

ETH 1x2 Call Spread Expiring March 2024

• With At-the-Money IV trading below 38% in the March 2024 contract last week, we recommended opening a trade strategy, selling the $2100/$2500 1 by 2 call spread. Initiating this trade while collecting a slight credit presented a great upside play with an excellent risk/reward profile. The downside is limited to $390, with unlimited upside and no premium outlay.
• Despite the selloff of the past two days, implied volatility has rallied on the move to 41.75%, resulting in a slight gain of $5 on the strategy.
• We recommend holding the trade at current levels and looking to roll the strikes down (closer to at-the-money) should the selloff continue.

ETH 1x2 Iron Butterfly Expiring March, 2024

• Last week, we recommended a strategy of selling one March $1900 Straddle and buying two $1600/$2200 Strangles.
• Similar to the call spread ratio, there was zero outlay of premium.
• Being a long vega trade with positive gamma, this trade shows a gain of $66 on the week.
• We see very little downside risk, so we recommend holding this strategy and would look to cover the short deltas near the close today.

ATM IV Term Structure

• With the exception of the August 25 Expiry, the term structure remains in contango this morning.
• Steepness of the contango has softened, however, given the move lower in the market.
• September options present the best value across the curves in both BTC and ETH.

At-the-Money Spot Month Daily Implied Volatility

• Implied Volatility was trending lower on a daily basis amid the lack of Realized Volatility in the market.
• The selloff of the past 24 hours resulted in a pop in Implied Volatility, especially in the front end.
• Given the volatility of the past few days, breakevens in both products (particularly in the September contract) are still historically low.

Front Month IV Curves

• 1 Week BTC 25 delta puts priced 6.5 vols over ATM, with 25 delta calls priced 0.5 vols over ATM.
• 1 Week ETH 25 delta puts priced 6.75 vols over ATM, with 25 delta calls priced 0.75 vols over ATM.
• Put skew in has firmed significantly in the past 24 hours as expected given the move in the market.
• Stubborn call premium in BTC has finally given way to puts in BTC, and both curves have similar smile structure.

BTC & ETH 25 Delta Skew (30 day)

• ETH Skew has been trading at a put premium for the past few weeks with an exception during the XRP ignited runup.
• BTC Skew remained toward the calls until this morning, finally breaking below flat and showing a 3% premium to the puts.

Notable Headlines

Bitcoin, Ether price slump leads to crypto bloodbath with $1B in liquidations (Link)

SEC Expected to Approve Ethereum Futures ETFs by October: Report (Link)

Grayscale Bitcoin Trust Discount Narrows to Lowest Since May 2022 (Link)

Single Trader Lost $55M on Ether Long Yesterday (Link)

Crypto Lender Exactly Hit by $12M Bridge Exploit (Link)

Bitcoin falls to lowest level in nearly two months after Fed minutes dial up inflation concerns (Link)

Interest Rate Jitters Sink the Heavyweights of Tech (Link)

BTC price nears $26K amid warning Bitcoin sell pressure can ‘double' (Link)

Coinbase CEO Says It's Easier to Do Business in Canada (Link)

40% of Workers Will Need New Job Training Due to AI: IBM (Link)

Coinbase gets approval to offer crypto futures to U.S. retail investors: CNBC Crypto World (Link)

Appendix: Glossary of Key Terms

Implied Volatility - represents the market's expectation of future price fluctuations and is a key metric employed to price options contracts.

Realized Volatility - also known as historical volatility, this measures past market changes and their actual results.

Delta - a measure of the change in value of an option given a change in the underlying futures contract.

Vega - a measure of an option's price sensitivity to changes in implied volatility.

Gamma - a measure of the rate of change in delta given a change in the underlying futures contract.

Theta - a measure of the rate of decline in the value of an option over time.

Rho - the amount a theoretical option’s price will change for a corresponding one percentage-point change in the interest rate used to price the option contract.

Implied Volatility Curve - a U-shaped graphical representation of the pattern created by the implied volatilities of multiple options contracts with the same expiration date.

Term structure of Volatility Curve - the curve depicting the differing implied volatilities of options with the same strike price but different maturities.

Break-even - the amount of underlying movement the trader needs to capture in hedged P&L via gamma to offset daily theta.

Support and Resistance - key price levels in technical analysis that indicate the levels at which buying or selling pressure is likely to be strong enough to prevent the price from moving below or beyond that level.

Paper - institutional player or producer, a non market-maker.

Call - an option that gives the buyer the right, but not the obligation, to buy the underlying asset at the strike price any time before it expires.

Put - an option that gives the buyer the right, but not the obligation, to sell the underlying asset at the strike price any time before it expires.

Roll - to simultaneously close one option position and open another with the same commodity but a different strike price and/or expiration month.

Straddle - an options trading strategy that involves buying both a call option and a put option at the same strike price and expiration date.

Strangle - an options trading strategy that involves buying both a call option and a put option at different strike prices but with the same expiration date.

Put Spread - an options trading strategy that involves buying a put option at a specific strike price and selling another put option at a lower strike price, both with the same expiration date.

Call Spread - an options trading strategy that involves buying a call option at a specific strike price and selling another call option at a higher strike price, both with the same expiration date.

Iron Condor - an options trading strategy that involves simultaneously buying equidistant out-of-the-money call spreads and put spreads.

Call/Put Calendar - an options trading strategy that involves buying an option at a specific strike and selling an option at the same strike across different expirations.

Butterfly - an options trading strategy that involves buying one low strike and one high strike option and selling two middle strike options.

Iron Fly - an options trading strategy that involves buying and selling three options at the same expiration date and strike price. The strategy consists of buying one call option and one put option at the middle strike price, and selling two options at different strike prices that are equidistant from the middle strike price.