In this week’s Desk Commentary, we’ve included some reflective thoughts about the options market.

  • Taking a step back, it’s instructive to ascertain where are we, and how we arrived here in the context of option market dynamics. From a recent high of nearly 21000 on November 7th, bitcoin plunged ~25% over just two trading sessions to make fresh lows for the year.  Ether followed suit (though failing to pierce the 1,000 threshold). Vol surfaces had, generally speaking, probed troughs not seen since the summer chaos.  1 month BTC atm IVs that had closed sub 50% on November 3th breached 100% annualized on November 9th, for instance; 90 day 25 delta risk reversals similarly spiked from levels below 5% to over 25%.
  • Yet even as the digital asset ecosystem continues to work through an industry-wide crisis, the storm in vol markets has, ostensibly, already passed.  Front-end btc and eth IVs have sagged back below 50% and 70% respectively, while medium term to longer dated vol has reverted ever closer to a global nadir, with 3month and 6month atms probing 60% and 65% respectively in BTC.  In ETH, relatively less liquidity and sparse participation sees same tenor vols still a reasonable margin off their pre-Terra and pre-FTX lows (by 5-7 vol points), though considerably well below recent panic highs.
  • Skews have tended to remain relatively stickier upwards (in the context of 15 vols over for 25 delta puts vs calls) given the market’s (rational) expectation of negative spot vol correlation from the present baseline of volatility, and as spot has rallied off the lows of ~15.5k in btc and a shade above 1000 in eth, IVs on OTM calls have indeed consistently underperformed even the fairly well discounted sticky strike assumptions embedded in the smile.
  • Though call spreads may look optically attractive, with spot so far off the lofty local highs of the summer (to say nothing of the ephemeral ATLs achieved what seems like eons past), it is not irrational to ask, just how sanely priced are far OTM calls in this environment and precisely how well could one expect variance to realize, particularly if risk were to rerate to the upside (or if vol were to experience another geometric increase). With slightly greater than 10 delta call strikes for September 2023 priced at 3-4% of spot with vols in the neighborhood of 70-75 for btc and 85-90 for eth, the raw aesthetics may not be so compelling, particularly given the somewhat more convex portion of the surface where these live that sees 10 delta call wing IVs sitting roughly 10 points over the 50 delta strikes in BTC, for instance.
  • As such, this is a circumstance where meatier spreads may, depending on the needs of any particular actor, be better suited for the passive delta player looking to gain reasonable exposure to a further rally in prices.
  • Yet those same steep smiles could still be, in a sense, theoretically justifiable for the essential call on vol itself that is afforded by the ownership of longer dated, long delta instruments given the wide range of observed levels.  Nonetheless, a fair value mechanism for the price of that exposure remains, however, heuristically elusive and depends innately on one’s assumptions about the distribution of crypto vol (and not merely the profile of returns themselves).

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