OTC Desk Market Update - August 21st
Volatility strikes back! This week we drive into the recent tumultuous events in the cryptocurrency market. After weeks of range bound price action this week was marked by significant price collapses in digital assets and extreme volatility. We explore the cascade of factors that led to the sharp price drops, including the disconnection between implied volatility (IV) and spot moves, and the challenges posed by drying liquidity in the market. But first we preview this week's upcoming macro events.
Macro
The Federal Reserve's Economic Policy Symposium, set to commence on August 24 in Jackson Hole, Wyoming, is THE macro event on everyone's calendar this week. At the event last year Chairman Powell cautioned about potential economic challenges, highlighting that higher interest rates and slower growth would lead to both reduced inflation and economic discomfort. According to Chris Rupkey, Chief Economist at FWDBONDS, last year, he interpreted Powell's message as a reminder of the lengthy journey required to achieve the Fed's 2% inflation target. However, this year, Rupkey anticipates that Powell's speech will signal a shift away from considering a rate hike at the September Fed meeting. With the consumer price index (CPI) having declined from its peak of 9% to around 3%, economist Stephanie Kelton from Stony Brook University hopes Powell's speech would convey a more relaxed message, perhaps stating, "Inflation has come down significantly since we were together last year. Let's all go fishing." Nevertheless, Kelton expects that Powell will likely emphasize the conditional nature of any future rate hikes based on incoming data. Currently the market is pricing in a 9.5% probability of a rate hike at the next Fed meeting.
Crypto
The return of volatility in crypto markets was undoubtedly the story of the week after months of historically low Implied and Realized Volatility. Thursday saw 7-day Implied Vol spike into the 50’s for both BTC and ETH, which of course had a corresponding sell off in spot prices for both assets. The sell off began slowly with BTC and ETH having consecutive down days on Tuesday and Wednesday, then all at once on Thursday with price falling over 9% in BTC and over 10% in ETH. Alt coins showed they are still highly correlated to BTC and ETH price movements with spot prices in alt coins falling in kind.
Realized and Implied Volatility
Last week we spoke about how unusual it was for crypto to be below a 30 implied and realized volatility for as long as it had been. The recent events show why this positioning doesn't last too long as we started to see dislocations between spot prices, implied volatility and realized volatility as the week progressed. The events that transpired represented an unexpected disruption to what had been the prevailing patterns in the cryptocurrency market. Despite generally favorable sentiment in the digital asset ecosystem and quiet macro calendar, a series of peculiar signals emerged leading up to the crash. The relationship between spot and volatility shifted. In the days prior to the crash, Implied Vols started to rise even as spot prices remained static and range bound, deviating from the recently entrenched positive spot:vol correlation. This dislocation was particularly evident in shorter-dated Implied Vols. Additionally, front-end risk reversals shifted from calls to puts, indicating a shift in market positioning and sentiment. The spike in volatility has not faded back to the low levels as we currently sit well above the average Implied and Realized vol we have been experiencing for the past few weeks.
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Term Structure and Skew
The endless volatility selling across the term structure of BTC and ETH ended with bang on Thursday, with term structure for both assets entering backwardation on the day of the sell off. The unwinding of short volatility positions resulted in front month vol spiking to 55+% on Thursday while backend vol spiked to 50%. This inversion in term structure is typical of option markets experiencing a spike in volatility. As it stands right now term structure in BTC and ETH are in contango, however the backend of each curve has shifted about 15- 20 vol points higher from the previous week. Skew in BTC has shifted towards puts in short-dated options. This is most evident in options expiring on AUG 25 and SEP 29, with September being one of the larger expiration dates on the calendar. Longer dated options have a bias towards calls the closer you get to 2024, which makes sense as traders are trying to position themselves for the upcoming halving. ETH skew has a similar profile except for longer dated ETH options being more neutral with no bias towards calls or puts. This makes sense as the halving narrative only applies to BTC and that is showing up in longer term positioning.
Flows and Positioning
Prior to the price collapse, notable trading activity emerged as a significant trader acquired approximately 1,000 1-week 10 delta puts with an Implied Vol just over 40%. This move prompted market makers to relinquish valuable gamma, convexity, and skew. The ensuing market turmoil was extraordinary, with spot Bitcoin swiftly plummeting from 27,700 to 27,000 and then further to 25,300, while ETH experienced a sharp decline from 1,720 to 1,550 before briefly recovering. Subsequent trading activity was marked by significant distress and upheaval, as exchange liquidations and triggered gamma and vega-driven stop-losses took center stage.
This tumultuous aftermath pushed the implied volatility surface to levels reminiscent of the FTX debacle, giving rise to remarkable market prints, including June 2024 40,000 strikes paid at 75% or higher, and a substantial increase in size for ~1-month ~25-delta calls.
Amidst the turmoil, liquidity began to dry up in an environment where liquidity is already low due to seasonality associated with the summer months. The established norms of the market, including the positive correlation between spot and volatility also broke down. The collapse in market liquidity could be viewed in gyrations of At The Money and Fixed Strike volatility. The shift in term structure to backwardation suggested that the market participants were complacent in thier short gamma and skew positioning and tried to unwind the position into a market that could not process the transitions without significant dispersion in spot prices. The question market participants must ask themselves now is are we entering a new volatility regime or will we return to the historically low levels of the previous months. We will be keeping a close eye on vol markets as the week progresses.
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.
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