A note on developments with derivative exchanges:
CME options open interest is exploding from negligible levels at the beginning of May to almost $170,000,000 notional as of 5/18/2020. This is almost 20% of Deribit’s OI. If the trend continues, the regulated exchanges will come to play a much larger or even dominant role in the Crypto derivatives market.
BTC spent the last week in a $1,200 range. The market has been trying to penetrate the $10,000 level, but so far has been unsuccessful. Technically we are still in an upward channel, with $9,000 being the short-term support and $11,000 being a short-term resistance. We should not spend much time below $9,000 for the channel to stay intact. The rising trendline should force a resolution of the $10,000 level by May expiry at the latest. Inability to do so would force a downward correction.
Realized 10-day volatility is up 2% to 84%. The option market is excited about the bullish price action, and implied volatility is up across the board with the deferred contracts appearing to be pricey.
Monday IV in December contract was up all the way to 92%. We apologize for a backward-looking statement, but it was a good level to lighten up on a long Volatility exposure. We warned in the previous report to be on the lookout for a profitable exit point for a long call skew/Volatility position.
Let us review last week’s recommendations:
· Traders should stay long call skew by buying calls vs. straddles on a ratio in September through December. It is time to formulate a strategy of reducing the call skew exposure in case it keeps appreciating. A move in skew or IV higher may bring this moment about shortly. Adjust the ratio to fit your IV view. We would be flat Vega here.
· Initiate May and or/June risk reversals (long Call/Short put delta hedged). The skew is very stretched and IV is low. We believe the call leg is undervalued. Equidistant risk reversal (10500/7500 vs 8950 future) is quoted to the put. There is a lot of downside fear already priced into the short-term structure.
· Contango in BTC spot to May CME contract is down to $67. It is worth utilizing the spread to enhance portfolio returns (spreads beyond May are still modest and do not appear attractive yet).
Long September to December skew strategies won on skew, Vega, and higher-order derivatives (moving into length on a rally to pick up extra Vega and Gamma on the way up). While call skew is still reasonable, the overall level of IV is on the expensive side. We recommend either reducing positions overall or selling straddles to keep Volatility exposure to flat or slightly short.
Shorter-dated risk reversals worked for June on skew and vol but lost money in May unless you exited right after the first move to $9900 due to relentless decay bill as you approach expiry. We still view short dated put skew as overpriced, but would roll May call positions to reduce decay.
Spot to May contango is down to $35-$40 as the expiry approaches. May-June widened to $83 (and traded up to $100 on Monday). Therefore, traders should start thinking of utilizing the June CME future to hedge their length.
This week’s recommendations:
· Traders should reduce Volatility exposure they have accumulated in their long call skew positions in the September-December periods. Call skew is approaching fair, but IV is elevated so continue to look for opportunities to sell into strength in calls (like the vol pop yesterday).
· Stay with May and or/June risk reversals (long Call/Short put delta hedged). The put skew is still relatively high. IV is reasonable. Manage the decay on May positions as it may kill the profitability of this trade unless we move towards the top of the channel soon.
· Contango in BTC spot to May CME contract is down to $37. It is worth rolling any May shorts into June to enhance returns.
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.