“Crypto is too volatile…”

This sentiment echoes among many I’ve spoken with, especially following the recent Bitcoin ETF approvals.

The intrigue in crypto is growing, but so is the apprehension about its infamous volatility.

What if I told you there's a way to navigate this volatility and even profit from it?

The Crypto Options Market: A World of Opportunity:

Most are unaware of the surprisingly liquid crypto options market that not only presents significant 'edge' but also unique dynamics for profit with considerably less volatility.

Since I started trading crypto options over 3 years ago, the space has come a long way and is evolving fast.

You can use options to benefit from the high volatility to generate PnL, over and above simply buying crypto.

With a lot of different actors with varying levels of sophistication in the options market, there is a lot of edge to be found.

One of the Key Dynamics Where Crypto Options Differ from Equity Options:

Those of you in equities will know the 'spot-down, vol-up' dynamic; typically, implied vol increases as the spot falls, which is why puts have higher implied vols than calls.

In crypto, however, 3 years ago, it had a 'spot-up, vol-up' dynamic. Explosive upside moves caused the implied volatility of upside call options to be greater than that of downside put options.

In 2022, in what was a challenging year for crypto, we saw a change to a 'spot-down, vol-up' dynamic, mimicking equity options, then since last year, we’re back to a 'spot-up, vol-up' dynamic in most parts.

“I want to benefit from potential crypto gains, but I can’t stomach the volatility along the way."

You can use the above dynamics to hedge your crypto (via spot or futures).

With call vols typically above puts (especially further down the term structure), you can overlay zero-cost put spread collars, where you can sell a very out-of-the-money call option and buy a close-to-ATM put & sell a more OTM put.

If you see a pullback, it’s often possible to make money on both delta (spot move) & implied vol (benefitting from ‘spot-down, vol-down’ in a downturn, along with the time decay you earn along the way.

“I want to be hedged, but not cap my gains”

As well as simply buying puts, you can regularly take advantage of the volatility term structure to use calendars to your advantage.

For example, when the volatility term structure drops into steep contango, you can buy an at-the-money put & sell a further expiry out-of-the-money put for net 0 premium.

The high volatility of the term structure itself & regular kinks in the term structure give you frequent opportunities to monetise calendar trades.

A Word About Call Calendars:

A favorite of mine. The high volatility of the skew & term structures mean there are ample opportunities to put on, and monetise calendar trades in relatively short spaces of time, even in the 6+ month expiry buckets.

Call calendars specifically can be used for efficient margin use and to take directional or relative value vol exposure.

Bitcoin (BTC) versus Ethereum (ETH)

ETH is historically the higher beta asset, and although BTC and ETH are correlated, the “elasticity” of the beta allows for potentially lucrative relative value options trades between the 2 coins.

The ETH/BTC ratio is closely monitored by traders and opportunities often arise for outperformance trades, using options.

Last year also saw some significant call overwriting lows in ETH especially which, along with the lagging spot price, kept a lid on upside vols on ETH (a higher beta asset historically than BTC), where they were trading under BTC upside vols for a large part of the year.

The ETH vol premium returned going into this year, but the recent market pullback has put a lid back on this premium, offering some potentially compelling longer-term outperformance opportunities vs BTC, which can be structured to be zero-cost upfront.

Crypto - Home to Many Technical Analysis Traders:

The percentage of traders using technical analysis can be high, meaning that you can use this to your advantage when choosing strikes for your options trades.

Carry Trades: Systematic Volatility Selling:

In crypto, this is done by systematically selling short-term out-of-the-money calls versus your longs, especially during rallies where retail traders typically chase the upside, inflating near-term upside vols.

Where to Trade:

Deribit is the main crypto options exchange. Its smart portfolio margin engine allows you to efficiently run an options portfolio.

Auto settlement & upcoming cross-coin margining mean you can efficiently trade relative value trades between coins (i.e., BTC vs ETH) also.

For larger sizes & the best liquidity?

If you’re trading larger sizes and want deep liquidity coupled with very tight markets, look no further than Paradigm.

I’m regularly able to trade on Paradigm at, or close to, mids, even for some complex multi-leg trades. That’s impressive in Trad-Fi, let alone the nascent crypto ptions space!

Going Forward?

Exotic options & structured products have already surfaced and started trading, with the likes of Zerocap and Orbit markets offering liquidity. The structuring innovation in the space, especially in derivatives, is expanding rapidly.

In conclusion, whether you’re a volatility arbitrage or directional trader, there are many ways to profit from crypto by using options.

I’ve touched on some above, but there are many more.

Cheers,

Mani

P.S. Keen to dive deeper into this? DM me.