November 17, 2022
Crypto vol markets have increasingly taken on the habit of suspended animation with sporadic bouts of activity before another syncopated freeze. As an exemplar, gross options open interest, which had flirted with $7bn in early November, fell by over $1bn from 6.3bn to 5.3bn pre-post the collapse of FTX. Daily volumes, which had collapsed from a peak of ~$1.9bn on November 8th to a trough of $262mm on November 13th before surging back to $815mm the following day.
Those statistics define an environment in which options players have, in a preponderance of cases, elected to flatten risk while looking for greater clarity on the asset class overhang.
That trend may be in part because valuing volatility surfaces with the underlying ostensibly poised on a knife edge, which has left many hapless. Illiquid spot and linear derivatives markets has seen spot stagnate near local lows of 16000 btc/usd and 1200 eth/usd, while IVs settle into an arrhythmic febrility with step-function shifts in mids and erratically widening spreads.
With exchange margins rising, participation declining, and uncertainty remaining unabated, all else equal, one could expect a lower floor for implieds, but the dearth of deployable capital and blighted risk outlook are surely crimping price discovery, with concomitant effects on liquidity.
As a testament to the aforementioned propensity for vols to follow something akin to a jump process, a sudden spurt in vega demand (surprisingly for calls) emerged as a key feature of the mid-week session.
Nearly $50k in mid curve upside vega was bought in a single RFQ, lifting vols 5 points across fungible buckets, as the initial exhaustion of maker liquidity found no commensurate supply of vols at anything other than higher (and wider) prices. It is not unreasonable to be prepared for IV teleportation of this nature and a chronically elevated transaction cost to cross spreads and get execution. In that context, a thesis may be postulated that if current uncertainty persists, mid 60%s implieds for bitcoin will be bought, rather than sold, and hence that owning longer dated optionality at a lower quartile presents reasonable risk reward.
That being said, regardless of one’s view on the direction of IVs, pricing inefficiencies are apt to emerge and may tend to persist longer in this market, owing to a reduction of viable hedging venues, increasing collateral requirements, and inability to borrow / short or otherwise access perpetual futures liquidity that existed even as of last week. All of those factors could help keep risk adjusted margins (and return premium on the allocation of capital) in crypto options elevated, provided that participants choose to remain engaged with the asset class (and the derivatives subsector).
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