OTC Desk Market Update: A Return to Optimism? A Deep Dive into Crypto Flows and Volatility
Welcome back to our weekly market update! Here are the top things we’ll be paying attention to this week:
Macro
Inflation Data and the Federal Reserve's Stance According to the latest data from the U.S. Commerce Department, inflation rose in line with expectations in February 2024. The Personal Consumption Expenditures (PCE) price index excluding food and energy increased 2.8% on a 12-month basis and was up 0.3% from the previous month. The headline PCE reading, which includes volatile food and energy costs, showed a 0.3% increase for the month and 2.5% at the 12-month rate. Rising energy costs and inflation pressures from the goods side contributed to the inflation increase. Analysts project this data is likely to keep the Federal Reserve on hold before it can start considering interest rate cuts, as the central bank considers core PCE inflation (excluding food and energy) to be a better gauge of long-term inflation pressures. The Fed targets 2% annual inflation, and core PCE inflation hasn't been below that level in three years.
Market Expectations and the Federal Reserve's Projected Rate Cuts
The market is pricing in that the Federal Reserve will remain on hold again when it releases its next interest rate decision on May 1, then begin cutting interest rates at the June 11-12 meeting. This is in line with the Federal Open Market Committee's (FOMC) projections for three quarter-percentage point cuts this year and in 2025.?
Crypto Market Overview
Implied and Realized Volatility
The week began with a considerable divergence between implied and realized volatility in both Bitcoin (BTC) and Ethereum (ETH). Notably, despite a significant increase in realized volatility, with Bitcoin's 10-day realized volatility returning to the low 80s and Ethereum's reaching as high as 100, implied volatility remained relatively unchanged. As the week progressed, realized volatility fell in line with implied, currently sitting in the mid 40s, for both BTC and ETH. This decline in volatility does not reflect a lack of option volume, rather it reflects the maturities that are being purchased, with a majority of the buying happening in short-term options. Longer-term options are more sensitive to volatility and reflexively push up implied volatility when purchased. The back-end of the term structure has remained relatively stable over the last two weeks which shows a lack of substantial net Vega demand (longer maturity options).?
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Term Structure and Skew
Term structure has remained in contango, though slight shifts in the curve have been observed. The front end of the curve has completely collapsed to its lowest level since August 2023, while a modest push higher in the mid-curve has been noted, especially in Bitcoin's April 2024 options. On the other hand, skew shows a significant turnaround from a predominant put skew to a more balanced or even call-favored skew in certain Ethereum front-end options. This shift underscores the market's changing sentiment and risk perception.
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Options Flows and Positioning
Options flow data indicates an active market, with traders shifting positioning from a week ago to calls and call spreads in both Bitcoin and Ethereum options. Bitcoin volumes have experienced a decrease, while Ethereum volumes have remained relatively stable, albeit with a slight decline. We did see a return of the willingness of traders to purchase out-of-the-money calls and at-the-money straddles, in anticipation of the upcoming Bitcoin halving, which has historically coincided with market movement and volatility. With that being said, past performance is not indicative of future events. Only time will tell. Dealer positioning in Bitcoin and Ethereum highlights that market makers are short gamma at the local strikes. Moreover, the disparity between Bitcoin and Ethereum in terms of volatility expectations and optionality preference suggests a market consensus leaning towards Bitcoin for potential significant moves, influenced by the upcoming halving and the delay in the ETH spot ETF.
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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.