Vol Commentary – Week 45, 2022

Cumberland is commenting on the recent volatility and potential opportunities to take advantage of it.

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November 9

What we are seeing in the markets

Crazy start of week as FTX insolvency sent shockwaves through the crypto community. Volatility explodes higher as BTC makes new yearly lows, ETH collapses 25% and SOL some 50%. BTC end of month vol currently sits around 93%, ETH around 133%, or 15.8% and 22.3% breakevens for the corresponding straddles. Risk reversals push to the put: 20 vols for the 1sd wide combo in Eth Dec. Backend vol also bounced to >90% in ETH and >70% in BTC. We think the surface remains badly mispriced and highlight some trade ideas.

Potential trades

1) Position for continued volatility by buying short dated delta hedged ETH calls.

On Oct 26th, we discussed the 11th NOV 1,400 put. While this option has performed extraordinarily well, we think calls are still underpriced: the 1,250 call is only worth 200bps. We see several catalysts motivating us to buy this option delta hedged. First, Binance / FTX takeover headlines will likely create additional volatility either direction. Second, the main event of the week is still due: US CPI is expected to shine significant light on the timing of a Fed pivot and the height of peak rates. This delta hedged call does particularly well on a retrace of this break while providing protection in case of a further selloff.

2) Play the reversal by selling long dated calls offset by buying short dated puts.

For instance, June 1,600 Calls are worth 19% (90% IV). Delta hedged, we think the price of this option will significantly normalize on a rally. We expect this vol level to trade around 80% within a week if the crypto space doesn’t collapse further. We are already seeing large vol sales on every uptick and expect this dynamic to push vol path much further than what the skew implies. Good protection against the vol short includes purchase of shorter dated puts that come in extremely high demand on selloffs (e.g. Dec 1k puts for 115% IV). Note that we like this play just as much in BTC, where miners default risk is increasingly exacerbated as BTC falls. BTC riskies are cheaper (12 vols in Dec), reflecting lower realized downside since the beginning of the week. If history is any lesson, the full scale of this new credit event will take time to fully reveal itself. The market is as always over-leveraged and needs protection. Own puts.