Option Traders Sniff Out Downside Risk As BTC Skew Shifts

Crypto Calmness Amidst Stormy Macro

The rather placid landscape of large caps BTC and ETH continues a week on. Key news and price fluctuations have been relatively scarce, echoed by the dormant sentiment.

In the absence of compelling storylines in cryptos, we find ourselves particularly focused on the broad economic implications stemming from the continued discussions around the US debt ceiling. These talks remain stuck in the mud as politicians appear to be at an impasse once again.

This debt ceiling saga only heightens existing uncertainties in the crypto realm, driven by various factors including renowned regulatory uncertainties, the looming spectre of a US recession, a tapering of activities from significant crypto market makers, a stronger USD, potential instability in the regional US banking sector, and the prospect of government sales of seized tokens.

Regrettably, there appear to be no unique narratives or events within the crypto sector that could disrupt this status quo in the immediate term. As such, the performance of large-cap cryptos remains inextricably linked to broader macroeconomic conditions.

Turning our attention to these macroeconomic conditions, this week’s highlights include the US PCE, anticipated to reflect recent subdued CPI trends, and the FOMC May minutes, expected to underscore the Fed’s “wait and see” stance.

Realized & Implied Vols Shot To Pieces

As the boundaries within which crypto trading oscillates continue to constrict, we have observed a sharp decline in realized volatility, now sitting below 30% for both Bitcoin (BTC) and Ethereum (ETH). This marks the lowest levels we’ve seen thus far in the year.

Implied volatilities have also been drawn downward, chiefly due to the weight of maintaining theta bills, further fuelled by a continual influx of fresh option supply steered by yield-earning mandates.

A significant positive carry has re-emerged within the 10-15 vol point range, as implied vols struggle to keep up with the dip in realized vol, all under the cloud of continuing uncertainty surrounding the US debt ceiling in the minds of investors.

Interestingly, crypto markets haven’t shown decisive alignment with other asset movements, as the correlation continues to wane. This suggests that narratives specific to cryptos will be needed to disrupt the current stalemate, barring any significant shifts in the broader macro landscape.

Navigating the Contango As Volatility Stays Suppressed

The term structure of Bitcoin (BTC) has been forcefully pushed back into contango due to the collapse of volatilities brought about by subpar realised vol.

Meanwhile, Ethereum’s (ETH) curve exhibits a steeper contango than Bitcoin’s, as Ethereum’s realized volatility drops below Bitcoin’s, pushing front-end Ethereum vols to fresh lows.

There has been a slight upward shift in the ETH/BTC volatility spread this week, as medium-term Ethereum volatility stands its ground relatively well, given its current affordability.

Judging by the levels of the volatility spreads, we maintain that a long bias towards Ethereum volatility continues to be a sensible approach.

If realised volatility persists at low levels, calendar spreads could potentially steepen further. Consequently, holding a medium-term Ethereum downside against a short-dated Bitcoin at-the- money (ATM) position could present an intriguing relative value, low theta strategy.

Skew: Impacted by Call Supply and Debt Ceiling

The call skew, which was observable across the Bitcoin (BTC) term structure last week, has evaporated as spot failed to instigate a rally and call supply flowed in from overwriters. This has nudged skew back towards a slight put premium, especially noticeable in the mid-range of the curve (1m-3m).

In comparison, Ethereum (ETH) skew has demonstrated more stability in the put premium, largely due to the perception that it is more likely to trade downwards with risk assets and not rally to safety as Gold and Bitcoin have done amid the recent banking upheaval.

We think that the shift towards put skew across both assets is indicative of the risk that upon raising the debt ceiling, net liquidity will retreat as the Treasury General Account (TGA) is replenished by fresh bond issuance. This scenario would drain dollar liquidity from the system, creating a drag on crypto markets and other risk assets.

With the recent uptick in medium-term Bitcoin skew, we suggest that put switches – specifically going long on ETH and short on BTC – may be a savvy approach to hedging against potential downsides.

Option Flows And Dealer Gamma Positioning

There has been a slight reduction in BTC options volumes this week, with a noticeable lean toward volatility trades over the usual directional plays.

We did observe early purchases in the upside 28k-32k strike zone for 26th May and 30th June. As markets remained range-bound, gamma sellers made their appearance via a 26th May 27k straddle.

Ethereum (ETH) flows continue to be dominated by call sellers, keeping a lid on implied volatility.

Yield earners have been pushed out as far as 29th September, as vols have dropped and taken premiums lower. There’;s still an overhang from a sizeable June/September 2200 call calendar (60k options, substantial Vega supply).

As per dealer gamma for Bitcoin (BTC), it has returned to a neutral state after briefly turning positive following last week’s expiry. The primary strike for Friday sits at 27k, which dealers seem to hold long.

As for Ethereum (ETH), its gamma positioning remains long and continues to extend as the spot price stays tethered near 1800, and the 26May expiry dominates heading into Friday.

Strategy Compass: Where Does The Opportunity Lie?

We maintain that ETH/BTC spreads are not sustainable at these levels longer-term. This is why we think owning ETH downside in Sep23-Dec23 expiries vs selling BTC either equivalent downside or Jun23/Jul23 ATM vol to control theta bills. With ETH stakers now happy to sell calls and seemingly vol-insensitive, we suspect that ETH vol can only catch a real bid on the downside.

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