Bitcoin’s options market continues to grow, along with an institution-led bull run in the leading cryptocurrency. While many use options to hedge their positions, the large amounts of Bitcoin options that are due to expire in a few days can even cause wild price swings as January ends.
As of press time, 120,300 $ 4 billion contracts on major exchanges Deribit, CME, Bakkt, OKEx and LedgerX expire this Friday, according to data source Skew. Much of this amount can be found on Deribit, the world’s largest exchange for crypto options by trading volume. It’s on track to see a record monthly expiration for Bitcoin options of 102,162 contracts (nearly $ 3.5 billion).
A call option gives the holder the right, but not the obligation, to buy the underlying asset at a specified price on or before a specified date. A put option represents a right to sell. In the case of an out-of-the-money call (OTM), the exercise price is higher than the spot price. At press time, call options are available at exercise prices above the current spot rate of $ 34,500 OTM. In the meantime, put options on strikes below the spot price are also OTM.
Market makers can cause volatility
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Option expiration times rarely have a direct effect on the spot price. However, when Open Interest focuses on call-and-put (OTM) options, as it does with Bitcoin, a sudden move prior to expiration forces market makers to hedge with the underlying asset. This leads to greater price turbulence.
Over 80% of open derivative open interest on January 29 is expected to expire out of the money or worthless. In particular, more than 52,600 call option contracts and 29,800 put option contracts are currently OTM, as the Swiss-based data provider Laevitas has determined.
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The story goes on
“If BTC quickly jumps to an all-time high in the next few days, market makers are likely to aggressively hedge their out-of-the-money short call option risk, which would likely increase overall market volatility and the dynamics of the underlying price. Samneet Chepal, a quantitative analyst at Ledger Prime, a quantitative and systematic digital asset investment firm, told CoinDesk.
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Market makers are individuals or member companies of an exchange who create liquidity in the market and take the opposite side of the deal initiated by traders / investors.
Given the recent strong upside sentiment and massive buying of higher strike and out of the money call options, market makers across the board are likely to be net short gamma (call sellers) according to Chepal.
Option gamma is the rate at which the delta changes based on a $ 1 change in Bitcoin price. Delta measures the sensitivity of the option prices to changes in the spot market price.
To be short gamma means to be an option writer (seller) regardless of whether he calls or bets. In this case, market makers are short gamma due to call selling. This makes them vulnerable to a sudden change to the higher side.
If Bitcoin recovers during Friday’s expiry, the market makers can aggressively hedge their OTM short call exposure by taking a long position on the spot market, resulting in increased price volatility and bull momentum.
Market makers are likely to step into action if Bitcoin hits an all-time high above $ 42,000 before Friday as most open positions focus on higher strike prices. “A massive part of the open interest is deeper OTM call strikes over $ 44,000,” Chepal said.
The data provided by the Genesis Volatility analytics platform show that the greatest concentration of open interest is in the call of $ 52,000.
“To protect themselves from an out-of-the-money outcome, options traders are likely to resort to delta hedging strategies,” Sui Chung, CEO of CF Benchmarks, told CoinDesk.
Delta hedging or delta neutral comprises several positions (long and short positions, call / puts) which aim to reduce and hedge the directional risk associated with price movements in the underlying.
For example, the delta of the $ 40,000 call expiring on January 29 is currently 0.10. This means that for every $ 1 change in Bitcoin price, the price of the option will change by $ 0.10.
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Another view is that investors currently long call with a $ 40,000 strike have a BTC delta exposure of 0.10. To hedge against the exposure, traders can short BTC 0.10 on the spot or futures market or buy a put option with a delta of 0.10.
Options traders generally hedge Delta with options. In particularly difficult times, however, they could also resort to hedging with the underlying asset itself, which, according to Chung, would lead to increased price volatility.
“This can create a vicious circle where increased volatility leads even more derivatives traders to rush to the same hedging strategies, which ultimately has the same effect as pouring oil on an open fire,” Chung said.
Bitcoin is currently trading near $ 34,100 after hitting lows below $ 29,000 last week, according to CoinDesk 20 data. As long as these options remain open in the market, the next few days could be interesting – and potentially volatile – for Bitcoin.