NDAX | Market Update: Unlocking the Low Volatility Puzzle — A Deep Dive Into Volatility Ahead of the ETH Futures ETF
Welcome back! Here are the top things to we’ll be paying attention to this week:
- Ethereum Futures ETF to start trading this week
- ISM Manufacturing PMI Report on Monday
- Non-Farm Payrolls Report on Friday
Macro
The deceleration in the U.S. Personal Consumption Expenditures (PCE) report for August brought relief to market participants, following consecutive accelerations in the Consumer Price Index (CPI) that had created uncertainty about the future path of the Fed’s rate hikes. This new PCE data supports the ongoing narrative of disinflation that has gradually become consensus.
Furthermore, consensus seems to be coalescing around the “higher for longer” theme as the bond market sold off last week, reflecting market participants readjusting future expectations surrounding the Fed’s commitment to maintaining higher rates. Markets are still pricing in rate cuts for 2024, and recent downside surprises in European inflation data reinforce this sentiment. The S&P 500 remained relatively unchanged on a week-over-week basis with utilities being the biggest underperformer, declining by 6.9%, while energy led the way with a 1.6% increase.
Crypto
With the launch of the Ethereum Futures ETF for American markets happening this week, we will keep a close eye on positioning in volatility markets, as we are already beginning to see distortions in the implied volatility term structure for ETH. Leading up to the quarterly options expiry last week, realized volatility in both BTC and ETH fell back into the 20s, continuing the low volatility regime we have been experiencing for the majority of the year. Although put-skew in BTC and ETH for the September options expiry was among the largest for the year, price failed to drift lower, causing the delta on those put options to decay. This, in turn, forced a gradual buyback of spot BTC and ETH by market makers who had initially hedged against selling those options by shorting the underlying assets.
After the expiry came and went with little fanfare, the biggest winner has been Solana, currently up over 12% at the time of this writing. BTC managed to reclaim the $27,000 USD level, while ETH also traded back above $1700 USD.
Realized and Implied Volatility
The volatility crypto experienced a few weeks ago has subsided, with realized volatility returning to the 20s. Over the past week, the 7-day realized volatility has been gradually declining, feeding back into lower implied volatility, albeit to a lesser extent.
What’s driving this low volatility? In the options market, we’ve witnessed a notable shift in preference among traders. Traders are leaning towards vega exposure (volatility exposure) over gamma (directional exposure). Long-term vega is suddenly in vogue, especially when it comes to Ethereum. The rationale here is that traders view volatility (vega) to be relatively ‘cheap’, considering the low volatility environment we find ourselves in and the pending ETH futures ETF. In essence, traders are looking at long-term volatility exposure and the spread between Ethereum and Bitcoin implied volatility and finding it quite attractive. However, there’s a hesitation to pile into options with substantial time decay.
The spread between realized volatility and implied volatility has returned to positive territory for both Ethereum and Bitcoin. Ethereum, previously trading with a negative spread, and Bitcoin, which only had a marginal positive carry, have both experienced a boost due to the low realized volatility. The persistence of this spread presents an opportunity for traders to sell options, as the market’s forecast for volatility (implied volatility) exceeds the actual volatility realized at expiration. Selling options has been the preferred trading strategy this year in the crypto market, especially in the absence of industry-specific catalysts beyond the spot ETFs.
Term Structure and Skew
BTC term structure remains in contango and has shifted lower from a week ago, a feature of the low volatility regime we have returned to. ETH term structure is exhibiting heavy distortion in the middle of the curve, with implied volatility trading lower in the later October weekly options and higher in the early October options. Typically, the implied volatility term structure is positively sloped, with longer-dated options having higher volatility than shorter-dated options. So, when the opposite is true, it is worth paying attention to, especially as we get closer to those expiry dates.
After the quarterly expiry, skew in BTC has undergone another transformation, displaying a more typical ‘volatility smile’ (demand for calls and puts being relatively neutral) across expiries. The first half of the year was characterized by call skew dominance as traders positioned themselves to capture upside in BTC through call buying. The September 29th expiry exhibited significant put skew, with most of those expiring worthless as BTC was able to hold its key support at $26,000 USD. Now, as we are firmly in the second half of the year, we are observing more neutral positioning in Bitcoin as gamma and volatility sellers begin to re-enter the market. ETH skew, which has broadly been neutral, is displaying a bias towards calls in the near-term options.
Flows and Positioning
Last week, we observed increased trading volumes, primarily driven by the quarterly expiry, totaling approximately $5 billion in notional for both Ethereum and Bitcoin. Notably, there has been a rollover of exposure in Bitcoin, with traders rolling over their premiums from the September expiry. Additionally, we witnessed traders repositioning themselves for upside, as October $30,000 USD strike calls were rolled into November $33,000 USD strike calls. There was also significant activity in the March 2024 calls, starting at the $40,000 USD strike. Ethereum’s options volume also experienced an uptick, with notable action in the October 27th $1900 USD calls, reflecting the increased call skew we discussed earlier.
Leading up to the quarterly expiry, positive gamma positioning had concentrated at the $27,000 USD strike in Bitcoin, which is approximately where the price settled on the day of expiry and heading into the weekend. As we’ve discussed in previous updates, extreme gamma positioning can influence the direction of price, acting like a magnet due to market maker hedging. Post-expiry, much of that exposure has shifted to the $28,000 USD strike, and BTC is now in a positive gamma regime.
ETH gamma, similar to Bitcoin, is now in a positive regime, with a high concentration of positive gamma at the $1700 USD strike, and smaller but still significant positioning at $1800 and $1900 USD. This shows a shift in trader positioning, as there is now increased demand for short-term calls. As the week progresses and the ETH futures ETF is rolled out, these gamma levels will become increasingly important.
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.
Check us out on X, Instagram, Facebook and YouTube.
Disclaimer: This article is not intended to provide investment, legal, accounting, tax or any other advice and should not be relied on in that or any other regard. The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of cryptocurrencies or otherwise.
