Volatility Update, 9/1/23

"For the investor who knows what he is doing, volatility creates opportunity." ~ John Train

We’ve been fielding questions about the extreme volatile moves in the markets of the past few weeks followed by periods of stagnation. As we’ve noted, there has been a significant lack of liquidity in the markets for the past few months, and research from Cryptoquant reveals that the total volume of Bitcoin held on all exchanges this month fell to its lowest level since 2018. Dealers have been steadily decreasing exposure or withdrawing completely from the market amid declining volatility and ongoing regulatory concerns. This lack of market depth and low volumes can make the markets susceptible to the exaggerated moves we’ve witnessed in reaction to the latest market developments. There are several factors at work here: (1) The aforementioned lack of market makers and light volume, (2) Summer apathy/risk off mentality, and (3) Short option book liquidations. For weeks, we’ve witnessed a consistent flow of options selling, compressing implied volatility in both BTC and ETH. Short Vol traders, convinced that the market was stuck, continued to pile into short options strategies looking to collect theta (overnight options decay) as the market remained rangebound. Recall, however, that the “cost” associated with positive theta is negative gamma, where gamma is the rate of change of delta of an option. (See slide 8 for a refresher.) What this means for a short options book is the delta exposure moves inversely to the price of the futures and it does so in an accelerating fashion. When markets are rangebound with little realized volatility, this strategy can be very lucrative since the trader’s delta changes very little. Conversely, when the markets sell off or rip higher in minutes (like we’ve seen the past two weeks), these players are forced to liquidate or attempt to hedge their books. In a product that is violently moving with little to no liquidity, they are adding fuel to the fire. This action further exacerbates these moves and often leads to extreme pricing in implied volatility as they race to cover. This also explains the lack of meaningful follow through in the markets. Once these liquidations are complete and/or positions covered, the market tends to readjust and wait for the next catalyst.

I mention this to, once again, highlight the importance of hedging or initiating smart, low risk/high reward trades during times of market calm and complacency. Taking advantage of the low implied volatility during these periods can prevent poor decisions in a fast market or lead to winning trades of 10x or more. Despite the recent volatility, options still appear underpriced. As we saw with the Grayscale ruling this week, market players are eagerly watching for any sign that the spot ETF applications may gain approval. Less publicized, the SEC on Monday submitted a sealed motion in its case against Binance, containing more than 35 exhibits. This is highly unusual and creates some uncertainty around their possible motivation. Yesterday, the SEC delayed its pending ETF application decisions until mid-October. Also worth noting is the historical September swoon the markets have experienced five years running, only to be followed by impressive rallies in October (see slide 3).

As is often the case, implied volatility is offered ahead of the long weekend as traders look to capture the extra day of theta. We believe much of this theta is already baked into options prices, so we advise clients to accumulate length at these levels. Implied Volatility for the October 27 expiry trading at 35% represents great value. BitOoda continues to recommend long options positions - our feeling is that in a market that historically averages both implied and realized volatility between 65-80%, a prudent hedger/investor is well suited trading from a position of length when IV levels are near historical lows, looking to opportunistically take profits on the exaggerated moves when IV pops 15-20% as short players scramble to cover.

Crypto Market Prices & Weekly Summary

The week began much like it ended, with futures trading in a tight range on light volumes. We did see a sizable buyer of ETH front end calls, with roughly 27,000 Sep Expiry 2000 calls trading through the past weekend and into Monday morning. Tuesday started off much the same until the announcement that Grayscale won its lawsuit against the SEC, which many believe will open the door for a series of ETF approvals. Spot price rocketed $2000 in BTC and $100 in ETH with Implied Volatility following suit, seeing the front-end rally between 7-10% on the backs of continued buying in September ETH calls, with 25k 1900 calls covered on the day. As one would expect, this pushed call skew up significantly and we saw positive call skew in ETH for the first time in months. The euphoria around the announcement proved to be short lived, however – on Wednesday, the markets retrace about half the gains and rolled over once again Thursday, completely negating the rally. As has been the trend, IV softened as the markets once again failed to follow through on the large move in underlying. This morning we find the markets down slightly with news that the SEC will further delay any rulings on spot ETFs and the Non-farm Payrolls report having little impact. It’s worth noting that despite sizable buying in short-term ETH options this week, implied volatility remains lower WoW. This indicates dealers encumbered with length are happy to sell to paper at these levels to reduce their exposure.

BTC Seasonality Correlation

• Historically, September has been a down month for BTC, followed by decent rallies in October.
• If history is an indication, buying BTC straddles with an October 27 expiry at current implied volatility presents an excellent opportunity to potentially capture decent moves in both directions.

ATM IV Term Structure

• Contango in the curve steepened despite the violent daily price action.
• October options present excellent value across the curves in both BTC and ETH as markets look to pick up post-Labor Day.
• BTC continues to trade at a vol premium to ETH, attributable to the anticipation of a spot ETF approval and the halving next April.

At-the-Money Front Month Daily Implied Volatility

• We witnessed intra-day spikes of implied volatility in the front end of the curve up to 10% this week.
• The market absorbed these spikes and with a lack of follow through, and implied volatility trended lower on the week, settlement to settlement.
• Break-evens in both products are trading near historical lows and present excellent risk/reward.

BTC & ETH 25 Delta Skew (30 day)

• Skew on the week proved to be more volatile than outright implied volatility prices moving as much as 20% in a 24 hour period.
• 30 day skew moved in direct correlation with the futures, indicating a directional bias.
• Should ETF applications gain approval, we expect a stickier put skew as institutions may begin to hedge crypto exposure much like we’ve seen in other, more mature commodity markets.

Front Month IV Curves

• 1 Month BTC 25 delta puts priced 2 vols over ATM, with 25 delta calls priced 1.5 vols over ATM.
• 1 Month ETH 25 delta puts priced 3.5 vols over ATM, with 25 delta calls priced 1.75 vols over ATM.
• BTC curve has flattened, removing the call skew we witnessed for the past few months.
• Put skew remains in ETH and near at-the-money calls trade fairly flat to ATM IV. Wingy calls and puts trade at a significant premium, indicating a demand for tail risk options.

ETH 1x2 Call Spread Expiring March 2024

• We will continue to monitor our past two recommended trade strategies in the ETH March ‘24 contract.
• We suggested selling the $2100/$2500 1 by 2 call spread. (Selling the $2100 call, buying 2 $2500 calls).
• Initially suggested as a long-term upside play, implied volatility has rallied on the move to 40.37%, resulting in a slight gain of $10 on the strategy despite a significant selloff in the futures market.
• 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

• Monitoring our second recommended 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.
• As a long vega trade with positive gamma, this structure has appreciated to a current value of $10.
• We view this as a long term strategy and recommend holding through year end and adding opportunistically.

Key Concepts

Notable Headlines

Grayscale Victory Against SEC Clears Path for Spot Bitcoin ETFs: Bernstein (Link)

SEC Delays Decisions on All Six Spot Bitcoin ETF Applications (Link)

SEC's Secret Binance Court Filing Has Observers Bracing for Bad News (Link)

Bitcoin on Exchanges Hits 5-Year Low (Link)

Unemployment rate unexpectedly rose to 3.8% in August as payrolls increased by 187,000 (Link)

Judge Dismisses Class Action Lawsuit Against Uniswap, Rules DEX Isn’t Liable for Scam Tokens (Link)

Bitcoin risks ‘swift’ $23K dive after BTC price loses 11% in August (Link)

Gary Gensler’s Crypto Approach Likely Won’t Be Slowed By The Courts (Link)

Bitcoin heads for red September, but analysts tip October as ‘days to watch’ (Link)

Bitcoin's Decline Continues for Second Month Despite Grayscale Ruling (Link)

Here’s the bitcoin outlook for September as crypto industry turns focus on Washington (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 underlyingfutures 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&Lvia gamma to offset daily theta.

Supportand 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, producer or hedger, a nonmarket-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 anytime 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 putoption at the same strike price and expiration date.

Strangle - an options trading strategy that involves buying both a call option and a putoption 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.