BTC continues to be rangebound. We have had essentially the same $700 range as last week. It appears that the bullish sentiment attached to the upcoming halving is being offset by the global turmoil surrounding COVID-19, the resulting financial market instability, and the strong dollar. While there is plenty of uncertainty, BTC has not resolved this tug-of-war.
A portion of this report is dedicated to Tail Risk Management in the face of uncertainty. There are many crypto ecosystem participants that are naturally long the space. BTC has not acted as “digital gold” lately. Many parts of the financial system are exhibiting extreme strain due to the global lockdown (examples include commodities, credit, and equities). BTC correlation to other assets has increased in this crisis. Therefore, firms need to make sure to allocate enough resources to remain solvent if another trip below $4000 materializes.
Realized 10-day volatility is slightly up to 69% from 65%. The range bound action has finally taken a toll on longer dated Implied Volatility. Longer dated options are the biggest losers this week.
Call skew is down in April and unchanged thereafter. Put skew is stronger in September and slightly weaker in July. From the historical perspective, call skew is cheap and put skew is fair to slightly high. However, given that implied volatility finally came down to earth, puts have become more reasonable as hedges or insurance, while still elevated as outright speculative trades.
Let us review last week’s recommendations:
- Get long call skew by buying calls vs. straddles or puts. We like meatier calls. Adjust the ratio to fit your IV view. We would be flat to slightly short Vol here. June is our preferred tenor.
- Exit or reduce the June / September straddle spread. That one has not worked out.
- Take profits on contango trades. Potentially roll spot length into futures to free up some capital.
June call skew trades worked on Vega and a little on skew. For example, June 12000/5000 risk reversal hedged vs. $6970 made $20 in price (from $210 to $190) and $30 on delta hedge (roughly 0.30 delta on $100 futures drop) for a $50 profit.
June September straddle spread is still around $1000, so while not losing money it has not made any either. Exiting the position saved you risk capital.
Contango is still low so there is no opportunity there.
Tail Risk Hedging
Given the uncertainty in the financial system and recent drop in implied volatility it is prudent for firms that are structurally long to implement TRH program if one is not already in place. The put skew is only slightly elevated vs. long term averages. The IV is high relative to recent realized vol but not much higher than longer term levels typical for BTC. Therefore, we do not have strong strike preference. In terms of tenor one can either buy short term protection that gets you to halving or spread out the hedges by buying a put strip (for example buying equal volume of May, June, July, and September puts).
The strikes should be chosen to balance the pain point for your firm with capital outlay.
Example: If your situation becomes dire below $4000 BTC price Buying a June $4500 for $210 guarantees that your realized prices do not drop below $4290 (strike price less premium) before option expiry for a $210 outlay. Buying a $4000 put for $145 saves on premium but moves the eventual price “floor” to $3855.
This week’s recommendations:
- Bullish traders should get long call skew by buying calls vs. straddles. Given the lower level of IV and market uncertainty we would avoid risk reversals. We like meatier calls. Adjust the ratio to fit your IV view. We would be flat to slightly long call vol here. Our preferred tenor is May and June post halving.
- Implement a risk management program if you do not have adequate capital to self-insure against a potential market drop.
The entirety of this report attempts to identify the best option structures available. Readers should overlay it with their directional view by under-hedging or over-hedging their preferred option structure.