Option volatility trends are great tools for VOL TRADERS to anticipate the near-term price action of the underlying product. Over the last few weeks, we have been actively tracking options prices in the digital asset market, and we’ve observed that Volatility for BTC options has been on a steady decline.
In a liquid options market, I was always taught, “Sell vol when it’s CHEAP, and buy vol when it’s EXPENSIVE.” This may seem counter-intuitive to conventional trading wisdom (i.e. “buy low, sell high”), but when it comes to option volatility, when options are EXPENSIVE, many times realized vol (actual movements of the underlying market) is greater than the theoretical vol (anticipated movements of the market = option price). The same is true vice-versa: when options are CHEAP, the realized price movements of the underlying are likely LESS than what would be anticipated.
Now with BTC options, this method or trading strategy would not be successful for a market TAKER, for three notable reasons:
1) Crossing the bid-ask in this options market will cut into PNL on each transaction
2) Lack of liquidity — IF you need to stop-out of a position that has gone wrong it will be very costly
3) Your counterparty will know your position when you want to close out and therefore pricing can be faded
Despite these current market inefficiencies, other derivative strategies can be implemented effectively. At this stage in the BTC and ETH options market, active TRADING may not necessarily be a profitable strategy, but using options as INSURANCE (their initial, historical purpose) is still good practice. We are seeing option VOL at low/CHEAP levels, so if you are looking to purchase some INSURANCE for your business/inventory now is the time to consider managing your risk. Remember, if you are looking to purchase INSURANCE, you do NOT want that contract to make money. If you buy homeowners insurance, you are not hoping your house burns to the ground — but having that protection is extremely important both financially and for your peace of mind. The same goes for companies; if you are long an inventory of BTC and you purchase puts as protection, if you lose on those puts you will be thrilled because that means your BTC inventory has risen in value.
In summary, we are starting to see BTC option VOL levels come down, and if you have a buy and hold strategy for these options contracts (i.e. insurance for current business/inventory, or long term directional view of BTC price) then now could be a good time to start looking into putting on these types of positions.
Figure 1. Chart of BTC 3-month ATM option volatility, http://www.sk3w.co/options.html