OTC Desk Market Update — The Crypto Conundrum: Will Low Volatility Continue?
Welcome back to our weekly market update! Here are the top things we’ll be paying attention to this week:
Macro Update
Inflation Slows to Three-Year Low
The Federal Reserve’s preferred economic measure, the Core Personal Consumption Expenditures (PCE) price index, showed a significant slowdown in inflation during May. The index increased by a seasonally adjusted 0.1% for the month and was up 2.6% from a year ago, marking the lowest annual rate since March 2021. This decrease in inflation is a positive sign for the U.S. economy and aligns with the Federal Reserve’s efforts to control rising prices.
PCE vs CPI: Understanding the Fed’s Preferred Measure
The Federal Reserve focuses on the PCE inflation reading rather than the more widely followed Consumer Price Index (CPI). The PCE is considered a broader inflation measure as it accounts for changes in consumer behavior, such as substituting purchases when prices rise. While the Fed officially follows headline PCE, Fed leaders generally emphasize the core reading as a better gauge of longer-term inflation trends.
Economic Indicators: Income, Spending and Price Changes
The Bureau of Economic Analysis report revealed mixed results for other economic indicators. Personal income rose 0.5% on the month, exceeding expectations, while consumer spending increased by 0.2%, falling short of forecasts. Prices were held in check during the month by declines in goods and energy costs, which offset slight increases in services and food prices.
The Fed’s Monetary Policy and Income Outlook
The Federal Reserve began raising interest rates in March 2022 to combat rising inflation, which it had initially dismissed as transitory effects from the COVID-19 pandemic. The central bank’s target inflation rate is 2%, and it has aggressively tightened monetary policy to achieve this goal. Recent economic data suggests that the economy has largely withstood these measures, with GDP growth remaining steady and unemployment rates staying low by historical standards.
Crypto Market Overview
Implied and Realized Volatility
Bitcoin (BTC)
With June now in the books and a crypto market down double-digit percent in most assets, holders of digital assets are looking forward to a new month after June produced a Realized Volatility (RV) of 31 in BTC. In an asset class that has been positively correlated with volatility over the last two years, a low-volatility month like June typically means a sideways market. However, June was both a month of low realized volatility and drawdown in prices, causing a noted increase in negative sentiment.
Implied Volatility (IV) didn’t fare much better, though we did witness periodic spikes on heavy selling days. Those spikes in volatility were short lived as gamma sellers came in to take advantage of the increase in premium, reflexively muting volatility in the process. As it stands right now, after Friday’s close Implied Vols have picked up heading into the week along with prices. Time will tell if this is a change in the recent trend or another head fake.
Ethereum (ETH)
Realized volatility in ETH, like BTC, has been in the low 30’s for the month of June. RV briefly touched 47 last Monday as markets sold off, but retreated back to the 30’s for the remainder of the week. ETH however has been experiencing higher implied volatility than BTC, which is mostly due to the anticipation around the upcoming U.S.-listed spot ETF. We saw a similar effect in BTC during the run up to its own ETF launch. ETH implied volatility has also begun to pick up heading into the new week with a high concentration of gamma at the $3,500 USD level, expiring on Friday.
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Term Structure
Bitcoin
Term structure in Bitcoin options has shifted to its lowest level since April, reflecting the low-volatility environment we spoke about previously. The front-end has sold off another 5 vols from a week ago, however the back-end of the curve remains relatively unchanged, down just a few points. The back-end of the curve represents options with longer than a month to expiry and demand for these options has remained relatively constant throughout the last month.
Ethereum
Ethereum’s term structure showed some steepening last week and that is more pronounced as the front-end of the curve has also sold off. Gamma sellers remain willing to sell ETH options even at these low levels as long as realized volatility remains contained and there is a positive spread between RV and IV. With the Volatility Risk Premium (VRP), a measure of spread between RV and IV, now in the single digits over the last 5 days and trending lower. It will be interesting to see how sustainable this trade remains going into July.
Options Flows and Positioning
Bitcoin
Deribit volumes are up about 12% heading into Monday with open interest at around $14 Billion USD to begin the week. 25 Delta risk reversals in near term expiries are still negative but are beginning to trend in the opposite direction. 25 Delta risk reversals measure the price of a call option with a Delta of 0.25 and the price of a put option that has a Delta of 0.25. If the skew increases then puts are becoming more expensive than calls; if the skew decreases, call premiums are going up against puts premiums. The near-term gamma strike price of note in BTC is $63,000 USD. This strike has a high concentration of negative gamma, meaning dealers will hedge in the direction of the market if price is hovering around this level on Friday’s option expiry. This could potentially amplify the move in whichever direction prices are trending. However, this effect can also be observed if price surpasses the level before expiry.
Ethereum
Ethereum options volume is only one third of the total market, however volumes are still up to start the week. Unlike BTC, 25 Delta risk reversals in ETH options markets are deeply positive with demand for calls evident across all maturities. Call skew in ETH has a premium relative to BTC in the shorter expiries because of this. The Gamma level in ETH to watch for Friday’s expiry is the $3,500 USD level.
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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.