Market Sentiment Signals - OTC Desk Market Update Sept 18th
Welcome back! Here are the top 3 things we’ll be paying attention to this week:
Macro
Following consecutive accelerations in PCE and CPI, markets are still not anticipating a Fed rate hike. The futures market is pricing in a 99% probability that the Fed will maintain current rates. The Fed has consistently emphasized its data-dependent approach throughout this hiking cycle, raising the question of why markets are so confident that there won’t be a hike.
As we noted last week, historically, under Jerome Powell’s chairmanship at the Fed, they have typically aligned their decisions with market expectations regarding interest rates. However, this was before Wednesday’s CPI report, which revealed that Headline CPI Inflation had risen to 3.7% year-on-year, with a 0.6% month-on-month increase. Although Core CPI inflation declined to 4.3% year-on-year, the lowest level since September 2021, it accelerated by 0.3% month-on-month. This leads to the possibility that market participants may not view the recent inflation upticks as significant enough to persuade the Federal Reserve Governors to vote for a rate hike.
This week’s meeting introduces the potential for intraday volatility if the Fed’s decision deviates from market expectations. Given the recent short-term acceleration in inflation data, it is a factor that must be considered if the Federal Reserve indeed remains data dependent. We will closely monitor Wednesday’s rate decision for any unexpected developments.
Crypto
After several weeks of significant turbulence in crypto markets, last week commenced with Bitcoin falling below the $25,000 level for the first time since June 14th, which had marked the local low just before the rally to $31,000. This decline in price was accompanied by a corresponding spike in realized volatility. However, on Tuesday the market began to rally in a manner reminiscent of the June upswing. As we approached Friday’s weekly options expiration, the rally lost steam, leading to consolidation into the weekend.
Realized and Implied Volatility
Realized volatility increased sharply, moving from the mid-twenties to the high thirties as crypto prices declined on Monday. As we moved into Tuesday, realized volatility continued to rise. However, this rise was accompanied by an increase in price, driven by traders showing a preference for call options. This resulted in the spot-up, vol-up correlation, which had been a prevailing theme before the 9% one-day decline in Bitcoin on August 17th. Currently, both Bitcoin and Ethereum have realized volatility levels in the high thirties.
Conversely, implied volatility has underperformed realized volatility, leading to a negative carry or spread between the two in BTC and ETH. Typically, implied volatility trades at a premium to realized volatility because it represents the market’s forward-looking estimate of where volatility could realize. A negative spread or a negative volatility risk premium indicates that conditions are not favorable for options selling, as this spread is what options sellers aim to capture by writing option contracts.
While Bitcoin’s 7-day implied volatility remains higher than that of Ethereum, Ethereum’s realized volatility is currently higher than Bitcoin’s realized volatility. This dislocation is an example of how positioning has shifted since the volatility selling that was dominating ETH, particularly at the 1900 strike, was abruptly unwound on August 17th.
As we approach the Fed’s decision, we will closely monitor whether the relationship between implied and realized volatility shifts. Typically, traders begin to buy put protection for their portfolios leading up to macro events, resulting in a rise in implied volatility. Additionally, the continued outperformance of Ethereum’s realized volatility relative to Bitcoin’s should be taken into consideration. If traders begin to shift their exposure to ETH options, this will manifest as a change in the spread between Bitcoin and ETH implied volatility.
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Term Structure and Skew
Term structure in Bitcoin continues to be in contango, with the front end of the curve shifting lower compared to a week ago, now dipping into the low twenties. This reflects the relationship between realized and implied volatility that we discussed earlier. On the other hand, the long end of the term structure remains relatively unchanged from a week ago, with only a slight increase in volatility observed in options expiring in 2024.
Ethereum’s term structure is also in contango, but is pricing in lower volatility than Bitcoin for both the front-month options and longer-dated options heading into 2024. This aligns with the market’s perception that the Bitcoin Halving and Spot ETF discussions are catalysts unique to Bitcoin. The premium in Bitcoin volatility across the term structure reflects this sentiment. It will be interesting to observe whether Ethereum’s realized volatility continues to outperform Bitcoin’s and if this influences positioning, potentially causing a reversal in the spread between the two assets.
The put skew in the September 29th options for both Bitcoin and Ethereum stands out significantly. Put dominance in the September 29th expiry has remained consistent since the start of the summer. This has typically been attributed to the September 29th date coinciding with quarterly options expiry in equity markets. With the added element of a Fed rate decision this week, the demand for puts as a protection becomes evident. This is reflected in the elevated put skew in the September 22nd options as well.
Both the FOMC meeting and quarterly options expiry can be considered known-unknown events. Market participants know when these events occur but are uncertain about the outcomes, driving demand for put protection. Below, we have included charts illustrating the skew for both Bitcoin and Ethereum in the September 22nd weekly options expiry and the quarterly expiry on the 29th. These charts clearly show an elevated put skew leading up to the FOMC meeting and highlight the magnitude of put dominance in the 29th expiry.
Examining these charts, we can see that a decline in Bitcoin’s price below the $25,000 mark would cause volatility to spike into the 50s, and a similar decline in Ethereum’s price below $1,500 would have the same effect. These levels are crucial moving forward, as the steepness of put skew for both assets indicates a sharp rise in volatility as prices declines.
Flows and Positioning
Much like the previous week, market flows in both Bitcoin and Ethereum were characterized by significant put protection buying, particularly focusing on September and December expiries. Notably, there was a substantial buying of December 20K puts in Bitcoin, along with the acquisition of 1400 puts in Ethereum. These actions contributed to the steep skew we discussed earlier, as these options are considered out of the money and are more sensitive to volatility.
Negative gamma positioning has started to accelerate in both BTC and ETH, driven by traders purchasing out-of-the-money puts to hedge their portfolios in anticipation of the Fed’s rate decision. In Bitcoin, dealer gamma slightly skewed negative, primarily within the range of 25.5K to 24K strikes. A similar trend was observed in Ethereum, ranging from 1600 to 1400. As we approach Wednesday’s rate decision, we will closely monitor whether we begin to reach extreme levels in gamma positioning, as that is when gamma becomes particularly relevant.
As always, our team is here to assist you and provide services tailored to your specific needs. If you would like to discuss these topics further, we invite you to book a meeting with our team. To schedule a meeting, please visit NDAX OTC | Bitcoin and Crypto OTC Trading Desk or contact your OTC representative directly. We look forward to assisting you on your investment journey.
Disclaimer: This article is not intended to provide investment, legal, accounting, tax or any other advice and should not be relied on in that or any other regard. The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of cryptocurrencies or otherwise.