Summary: Despite the strong rally in the Bitcoin spot market (+125% YtD), traders lacked interest in buying leveraged upside through Bitcoin options as volatility underperformed. The entrance of institutional players will dampen implied volatility. A trading strategy that loses money in two out of every nine trades (22%) is probably profitable – as selling strangles has proven to be this year. After the ETF approval, it could be the last chance to sell volatility on a structural basis, as institutions will structurally sell volatility from that point onwards.
Analysis
Introducing US-listed Bitcoin spot ETFs will fundamentally change the crypto options market. Despite Bitcoin returning +125% year-to-date, the average 30-day realized volatility has only achieved 41%, while the 5-year average stands at 63%. In other words, despite the strong rally in the spot market, traders lacked interest in buying leveraged upside through Bitcoin options as volatility underperformed. This observation will likely continue to play a significant role as institutional players aim to structurally arbitrage the (relatively) high implied volatility that Bitcoin options tended to be priced with.
Bitcoin options volume will likely continue to increase, but the entrance of institutional players will dampen implied volatility. The days of 50-100% implied volatility might be behind us. An institutional player holding a sizeable long position in Bitcoin would be incentivized to sell volatility and sophisticated enough to alter the market and keep volatility marked within a lower range. While there will be periods of extremely high volatility, those periods will only be temporary, and the Bitcoin derivatives market will resemble the TradeFi options market with the introduction of institutional players.
For every one Bitcoin put option outstanding, there are two calls outstanding, but this 1:2 (or 0.5) ratio for puts vs. calls is likely to fundamentally change after the introduction of the Bitcoin ETF. As a comparison, the put/call ratio for the SP500 has averaged between 1.2 to 1.5 this year – for every one call, there are 1.2 to 1.5 puts outstanding. This could be ‘the rise of the puts’ as more investors want to harvest volatility through a sell-put strategy.
Exhibit 1: +20% rallied in Bitcoin occurred on four occasions this year (30-day rolling return):
Selling strangles (120% call and 80% put) on a constant 30-day rolling basis would have seen those options being in the money in 23% of the observations during the last 1-year. During the end of the summer, this strategy would have been in the red in only 15% of the observations – compared to 50% to 55% during the DeFi summer period from June 2020 to October 2021. While this is an oversimplification, a trading strategy that loses money in two out of every nine trades (22%) is probably profitable – as selling strangles has proven to be this year.
Exhibit 2: Bitcoin (green) vs. frequency an 80% put and 120% call strangle selling strategy lost money:
While we were among the most prominent Bitcoin bulls this year, we also suggested that selling volatility is one of our favorite strategies. With the approval of US-listed spot Bitcoin ETFs, we expect implied volatility to decline materially in 2024. We suspect the weeks after the ETF approval could be the last chance to sell volatility on a structural basis, as institutions will structurally sell volatility from that point onwards.
In August 2023, 30-day realized volatility dropped to sub-20%. With the expectations of an ETF being approved in January 2024, realized volatility has increased to 43%, while at-the-money implied volatility has remained at 51%. Institutions will want to arbitrage this 8% (51%-43%) away on a constant, systematic basis, dampening Bitcoin’s volatility.
Previously, we showed how Bitcoin rallied into and after the CME Bitcoin futures announcement. When the SEC approves a Bitcoin spot ETF, prices will likely rally for several weeks afterward. However, volatility might underperform as the periods of parabolic price moves are behind us with the institutionalization of Bitcoin.
Disclaimer
This article reflects the personal views of its author, not Deribit or its affiliates. Deribit has neither reviewed nor endorsed its content.
Deribit does not offer investment advice or endorsements. The information herein is informational and shouldn’t be seen as financial advice. Always do your own research and consult professionals before investing.
Financial investments carry risks, including capital loss. Neither Deribit nor the article’s author assumes liability for decisions based on this content.
AUTHOR(S)
Author of the book “Crypto Titans: How trillions were made and billions lost in the cryptocurrency markets”. More info about Markus can be found here.