OTC Desk Market Update: Crypto Volatility Soars - What Traders Need to Know Ahead of FOMC

Welcome back! Here are the top things that we will be paying attention to this week: - U.S. Federal Reserve (FOMC) meeting on Wednesday  - U.S. Non-Farm Payrolls Report on Friday

Macro Overview

The Q3 Gross Domestic Product (GDP) report in the U.S. dealt a decisive blow to recession forecasters. U.S. GDP surged by 4.9% in Q3 2023, surpassing estimates of 4.5%. Initially, consensus forecasts began with a modest 0.5% increase, but they were compelled to adjust their projections upward as economic data consistently outperformed throughout the quarter. Presently, the Atlanta Fed's GDP nowcast projects Q4 GDP to be around 2.4%. Another notable data release was the Personal Consumption Expenditures (PCE) report. The headline PCE deflator increased by 80 basis points, reaching a six-month high of 3.7% on a three-month seasonally adjusted annualized basis (3-month SAR). Equally significant, the core PCE deflator accelerated by 50 basis points, hitting a two-month high of 2.5% on a three-month annualized basis. With growth and inflation gaining momentum in the last quarter, all eyes are now on the Federal Reserve. Despite rate hikes, aggregate demand remains robust, and PCE inflation has increased for two consecutive months. Having said that, the market is currently pricing in a 97% likelihood that rates will remain unchanged at the next meeting on November 1st.

Crypto Market Overview

Realized Volatility Explosion: After being trapped in the 30’s for what seems like an eternity, realized volatility exploded higher in Bitcoin (BTC) and Ethereum (ETH). This surge in realized volatility has led to significant price movements and impacted the options market.

Spot-Vol Correlations: Positive spot-vol correlations reached an all time high this week. A strong positive correlation between spot prices and volatility clearly signifies the strategic positioning of market makers. As the spot market surges towards price levels where dealers hold short positions in November and December options, the market experiences an increase in volatility, as dealers find themselves compelled to cover their positions.

Realized and Implied Volatility

Bitcoin Volatility: Realized volatility in Bitcoin has undergone a remarkable increase, breaking out of its previous range in the 30s and surging into the 60s. This surge coincided with a significant upward movement in Bitcoin's spot price, reaching $35,000 USD, reflecting the positive spot-vol correlation we discussed earlier. Bitcoin's implied volatility spiked as high as 70 last week, driven by the release of more news about BlackRock's spot Bitcoin ETF, including the discovery of BlackRock's ticker on DTCC's website. By the end of the week, implied volatilities had fallen into the 40s, even though realized volatility remained in the 60s, indicating the intraday market volatility experienced throughout the week. At the time of writing, implied volatility has started to rise again and currently sits in the low 50s.

Ethereum Volatility: Ethereum's 7-day realized volatility has also increased, reaching a level similar to that of BTC. ETH saw a 10% increase in the past week, benefiting from the same positive spot-volatility correlation as BTC. Although ETH's implied volatility did not reach the 70s as BTC did, the spread between the implied volatility of each asset narrowed as we approached the expiration of Friday's weekly options. Currently, the spread between ETH and BTC implied volatilities is approximately 3 vols down from its high of 15 on Monday. The uptick in Ethereum's implied volatility reflects increased demand in the options market, even as Ethereum experienced smaller price movements this year.

Term Structure and Skew

Bitcoin Term Structure: Front-month term structure in both assets has increased by 15 to 20 vols, with weekly volatilities doubling. This rapid expansion highlights the intensity of the recent price movements and suggests that option sellers who underestimated the crypto market's potential for breakouts may have been forced to liquidate their positions. The back end of BTC term structure is up about 5 vols from a month ago but barely in the last week. This shows that a majority of option flows have been trading in the shorter dated expires which is why front month term structure is where most of the moves have occurred.

Ethereum Term Structure: ETH term structure, much like BTC, has shifted higher by approximately 15 vols, with the back-end term structure increasing by 7 vols. Ethereum's lack of a compelling narrative has weighed on price action and, consequently, option flows throughout the year. However, the recent surge in BTC and other major crypto assets has rekindled interest in ETH. Additionally, these price movements have compelled option sellers, who were harvesting premium, to close their short call positions, particularly those concentrated around the $1,700 USD level.

Bitcoin Skew: Skew in both BTC and ETH experienced a volatile week, with oscillations in both call and put premiums. As we discussed in last week's newsletter, call-skew was dominating in the near-term expirations. It came as no surprise that Bitcoin's price surged, with market participants favoring calls to capitalize on the upward movement. However, this behavior reached its peak on Monday, and put-skew made a comeback afterwards as traders sought to hedge against downside risks. This positioning preceded the intraday volatility we witnessed throughout the rest of the week. As it currently stands, we are entering a new week with call-skew once again prevailing in both shorter and longer-dated expirations.

Ethereum Skew: ETH Skew has remained relatively neutral throughout the year, with only a few instances of imbalance between call and put premiums. However, this pattern shifted this week as traders started pursuing upside by strongly favoring call options. Unlike BTC, this behavior peaked later in the week, which was evident in the divergences in ETH's price compared to other crypto assets. As we kick off the week, call skew continues to be dominant in ETH, but put skew is introducing more neutrality in some of the longer-dated expirations.

Options Flows and Gamma Positioning

Bitcoin Flows and Gamma: Option flows have experienced an 85% increase in recent weeks, with long calls and short puts emerging as the prevailing strategies. The recent surge in bullish sentiment surrounding the impending spot ETF decision has injected new life into the options market as traders strategically position themselves for the forthcoming announcement and the 2024 halving. As previously mentioned, the positive spot-volatility correlation is significantly influenced by market maker positioning. Upon analyzing Bitcoin gamma, it becomes apparent that market makers are increasingly short calls. Notably, the $35,000 USD strike price exhibits the highest concentration of positive gamma, indicating that this is where the bulk of hedging activity occurs among dealers. Additionally, the $40,000 USD strike is gaining significance as we approach the year's end.

Ethereum Flows and Gamma: Last week, there was a significant influx of call buying in Ethereum (ETH), particularly focused on the $1,800 USD strike calls expiring on December 29th. Notably, there was short covering activity at the $1,700 USD strike as well. Traders who had been accumulating profits throughout the year by selling options found themselves compelled to exit their positions as prices surged higher. Similar to Bitcoin, ETH exhibits positive gamma, with the most significant concentration observed at the $1,700 USD strike, while the $1,800 USD strike is not far behind.

As always, our team is here to assist you and provide services tailored to your specific needs. If you would like to discuss these topics further, we invite you to book a meeting with our team.

To schedule a meeting, please visit NDAX OTC | Bitcoin and Crypto OTC Trading Desk or contact your OTC representative directly. We look forward to assisting you on your investment journey.  

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Disclaimer: This newsletter is for informational purposes only and does not constitute investment advice or an offer to sell or a solicitation of an offer to buy any securities or other financial instruments. The information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of the available data. Past performance is not a guarantee nor a reliable indicator of future results. Please consult your financial advisor before making any investment decisions.