Coinglass Report:
The approval of options is a significant victory for Bitcoin ETFs as it will bring deeper liquidity and attract larger players.
On October 18, the US Securities and Exchange Commission approved applications from the New York Stock Exchange (NYSE) and the Chicago Board Options Exchange (CBOE), allowing the 11 approved Bitcoin ETF providers to engage in options trading.
ETF analyst Seyffart stated at the Permissionless conference that Bitcoin ETF options may be launched by the end of the year, but there is no strict deadline from the Commodity Futures Trading Commission (CFTC) and the Options Clearing Corporation (OCC), so there may be further delays and it is more likely to be launched in Q1 2025.
Meanwhile, the SEC has postponed its approval of Bitwise and Grayscale Ethereum ETF options, speculating that this is due to the lower-than-expected influx of funds after the approval of the Ethereum ETF. The SEC wants to further investigate the impact of this proposal on market stability and will make a ruling on November 10.
Bitcoin and Ethereum ETF inflows and outflows:
Why are Bitcoin ETF options important?
Bitcoin options are contracts that give holders the right, but not the obligation, to buy or sell Bitcoin at a predetermined price within a certain period of time. For institutional investors, these options provide a means to hedge price fluctuations or speculate on market trends without holding the underlying asset.
These Bitcoin index options provide institutional investors and traders with a fast and cost-effective way to expand their investment positions in Bitcoin, offering an alternative method to hedge their exposure to the world’s largest cryptocurrency.
Why is the approval of Bitcoin ETF options particularly important? Although there are already many cryptocurrency options products in the market, most of them lack regulation, which discourages institutional investors from participating due to compliance requirements. Additionally, there is a lack of options products that are both compliant and liquid in the market.
The most liquid options product is offered by Deribit, the world’s largest Bitcoin options exchange. Deribit supports 24/7/365 trading of Bitcoin and Ethereum options. The options are European-style and settled in the underlying cryptocurrency.
However, due to being limited to cryptocurrencies only, Deribit users cannot cross-collateralize their margins with assets from traditional investment portfolios such as ETFs and stocks. It is also not legal in many countries, including the United States, without the endorsement of a clearing organization, making it difficult to address counterparty risks.
Bitcoin futures options from the Chicago Mercantile Exchange (CME) and Bitcoin options from LedgerX, a CFTC-regulated cryptocurrency options exchange, have significant bid-ask spreads. They have limited functionalities, such as LedgerX lacking a margin mechanism. Each call option on LedgerX must be sold in a valuable form (holding the underlying Bitcoin), and each put option must be sold in cash (holding the cash value of the strike price), resulting in higher transaction costs.
Options related to Bitcoin assets, such as MicroStrategy options or BITO options, have significant tracking errors.
The significant rise in the stock price of MicroStrategy since the beginning of the year indirectly indicates the demand for Bitcoin hedging trades. Bitcoin ETF options can provide the market with compliant and deep options products. Bloomberg researcher Jeff Park pointed out, “With Bitcoin options, investors can now engage in term-based portfolio allocation, especially for long-term investments.”
Enhancing or reducing volatility?
There is a debate on whether the listing of Bitcoin ETF options will have an impact on Bitcoin volatility.
Those who believe it may enhance volatility argue that once options are listed, many retail investors will enter very short-term options, similar to the gamma squeeze seen in meme stocks like GME and AMC. Gamma squeeze refers to the continuation of a trend due to accelerated volatility. As investors buy these options, their counterparties, large trading platforms and market makers, must continuously hedge their positions by buying stocks, driving prices higher and creating more demand for call options.
However, as Bitcoin has a limited supply of 21 million coins, if there is a gamma squeeze, the only sellers will be those who already own Bitcoin and are willing to trade at higher prices in US dollars. Because everyone knows that there won’t be more Bitcoin to push prices down, these sellers would also choose not to sell. There hasn’t been a gamma squeeze on listed options products, which may suggest that this concern is unwarranted.
The concentration of options expirations can also cause short-term market fluctuations. Luuk Strijers, CEO of Deribit, stated that the Bitcoin options expiring at the end of September were the second largest in history, with approximately $58 billion in open interest on Deribit. He believes that this expiration could result in over $5.8 billion of options becoming worthless, which could trigger significant market volatility after expiration.
https://www.coinglass.com/options
Historically, options expirations do impact market volatility. As the expiration date approaches, traders need to decide whether to exercise, let their options expire, or adjust their positions, which usually increases trading activity as traders try to hedge their bets or take advantage of potential price movements. In particular, if the price of Bitcoin is near the strike price at the expiration of options, option holders may exercise their options, which could lead to significant buying or selling pressure in the market. This pressure could cause price fluctuations after the expiration of options.
On the other hand, those who believe volatility will be dampened are looking at the long-term perspective. This is because option prices reflect implied volatility, which is investors’ expectations of future volatility. The introduction of IBIT options can attract more structured products and potentially lower volatility as excessive implied volatility would attract more options products to enter the market to flatten it.
A larger pool of funds attracts larger players
The introduction of options will further attract liquidity, and the convenience brought by liquidity will further attract liquidity, forming a positive feedback loop. Currently, there is almost a consensus in the market that the introduction of options is attractive to liquidity in terms of its own merits and the additional consequences it brings.
Options create more liquidity for the underlying assets as options market makers engage in dynamic hedging strategies. The continuous buying and selling from options traders provide a stable flow of trades, smoothing price fluctuations and increasing overall market liquidity, allowing for larger pools of funds to enter the market and reducing slippage.
The approval of IBIT options may also attract more institutional investors, especially those managing large portfolios, as they often require sophisticated tools to hedge their positions. This ability lowers perceived risk barriers and allows more capital to flow into the market.
Many institutional investors manage large investment portfolios and have specific requirements for risk management, purchasing power, and leverage. Spot ETFs alone cannot solve these problems. Options can create highly complex structured products, allowing more institutional capital to participate in Bitcoin.
With the approval of IBIT options, investors have the opportunity to invest in Bitcoin volatility, considering Bitcoin’s inherent volatility compared to other assets, which could lead to substantial returns.
Bitcoin annualized realized volatility:
According to Bloomberg analyst Eric Balchunas, the approval of options is a significant victory for Bitcoin ETFs as it will bring deeper liquidity and attract “larger players.”
Furthermore, the approval of IBIT options is another clear statement from regulators. Mike Novogratz, CEO of Galaxy Digital, stated in an interview with CNBC, “Unlike traditional Bitcoin futures ETFs, these options allow trading within specific time intervals, which could generate more interest from funds due to Bitcoin’s inherent volatility. The approval of ETF options could attract more investors. The trading volume of MicroStrategy reflects strong demand for Bitcoin. Regulatory clarity may pave the way for the future growth of digital assets.”
For existing options markets, the approval of ETF options will also bring greater gains. Joshua Lim, co-founder of Arbelos Markets, speculated on the Unchained Podcast that the liquidity growth of CME options will be most evident as both markets cater to traditional investors, and the arbitrage opportunities formed in the process will increase the liquidity of both markets.
Variant price performance
The introduction of options not only brings more diversified trading opportunities for investors but also unexpected price movements that were not anticipated before.
For example, Joshua Lim found that many people were buying call options after the election, indicating that people were willing to make some kind of hedge bet, believing that the regulatory environment for cryptocurrencies would relax after November 5. There is usually some price volatility around the expiration date of these options, and this volatility is typically highly concentrated. If many people buy options with a strike price of $65,000 for Bitcoin, typically, market makers will buy when the price is below $65,000 to hedge their risk and sell when the price is above this level, effectively pinning the Bitcoin price to the strike price.
If there is a trend, it usually materializes after the expiration of options, and there are many reasons for this. For example, options typically expire on the last Friday of the month, but this does not necessarily coincide with the end of the calendar month, which is particularly important as it marks the evaluation of hedge fund performance and the buying and selling of shares, creating inflows of funds and purchasing pressure in the asset class. Due to all these dynamics, there is indeed post-expiration volatility in the spot market as hedging activities by many traders may weaken after expiration.
Options do not trade over the weekend, and if the gamma value of IBIT is very high at the close of the market on Friday, it may force traders to buy Bitcoin spot over the weekend to hedge their delta. There may be some risks in transferring Bitcoin between IBIT as it is a cash-settled option. All these risks can ultimately spill over into the Bitcoin market, and we may see wider bid-ask spreads.
Conclusion
For institutions, Bitcoin ETF options greatly expand hedging capabilities, allowing for more precise risk and return control and enabling more diversified investment portfolios. For retail investors, Bitcoin ETF options provide a way to participate in Bitcoin volatility.
The versatility of options may also trigger bullish sentiment in the classic reflexivity of the market, and liquidity brings more liquidity. However, whether options can effectively attract funds, have sufficient liquidity, and form a positive feedback loop that attracts funds still needs to be validated by the market.
