CoinGlass Report:
The approval of options is a major victory for Bitcoin ETFs as it will bring deeper liquidity and attract larger players.
On October 18, the U.S. Securities and Exchange Commission (SEC) 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 could be launched before the end of the year, but the Commodity Futures Trading Commission (CFTC) and the Options Clearing Corporation (OCC) do not have strict deadlines, so there may be further delays, with Q1 2025 being the more likely launch date.
Meanwhile, the SEC has postponed the approval of Bitwise and Grayscale Ethereum ETF options, speculating that this is due to the lower-than-expected inflow of funds after the approval of the Ethereum ETF. The SEC hopes 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 having to hold the underlying asset.
These Bitcoin index options provide institutional investors and traders with a fast and cost-effective way to expand their Bitcoin investment positions and offer an alternative method to hedge their exposure to the world’s largest cryptocurrency.
Why is the approval of Bitcoin ETF options particularly important? While there are already many cryptocurrency options products on the market, most of them lack regulation, which deters institutional investors from participating due to compliance requirements. Additionally, there is currently no options product that combines regulatory compliance and liquidity.
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-margin their collateral 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 clearinghouse to address counterparty risk.
Bitcoin futures options from the Chicago Mercantile Exchange (CME) and Bitcoin options from LedgerX, a CFTC-regulated cryptocurrency options exchange, have a significant bid-ask spread. They have limited functionality, such as LedgerX not having a margin mechanism. Each call option on LedgerX must be sold for value (holding the underlying Bitcoin), and each put option must be sold for cash value (holding the cash value of the strike price), resulting in higher trading costs.
Options on Bitcoin-related assets, such as MicroStrategy options or BITO options, have significant tracking errors.
The surge 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 options products that combine compliance and trading depth. Bloomberg analyst 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 debate over what impact the listing of Bitcoin ETF options will have on Bitcoin volatility.
Those who believe it may enhance volatility argue that once options are listed, there will be many retail investors entering very short-term options, similar to the gamma squeeze seen in meme stocks like GME and AMC. Gamma squeeze refers to the tendency for accelerated volatility to continue as investors buy these options and their counterparties, large trading platforms and market makers, have to continuously hedge their positions by buying stocks, driving prices further up and creating more demand for call options.
However, with only 21 million Bitcoins in existence, Bitcoin is inherently scarce. If a gamma squeeze were to occur in Bitcoin, the only sellers would be those who already own Bitcoin and are willing to sell at a higher price in dollars. Because everyone knows there won’t be more Bitcoin to push prices down, these sellers will also choose not to sell. There has been no occurrence of a gamma squeeze in listed options products, which may suggest that this concern is unfounded.
The concentration of options expiring can also cause short-term market volatility. 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 in options expiring worthless, which could cause significant market volatility after expiration.
https://www.coinglass.com/options
Historically, options expiration has indeed affected market volatility. As the expiration date approaches, traders need to decide whether to exercise options, let them expire, or adjust positions, which typically 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 the options, option holders may exercise the options, which can create significant buying and selling pressure in the market. This pressure can lead to price fluctuations after the expiration of options.
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 for future volatility. The introduction of IBIT options brings new liquidity and attracts more structured note issuances, which could lead to a potential reduction in volatility because if implied volatility is too high, more options products will enter the market to flatten it.
A larger pool of funds attracts larger players
The introduction of options will further attract liquidity, and the trading convenience brought by liquidity will further attract liquidity, forming a positive feedback loop of liquidity. The current market consensus is almost unanimous that the introduction of options is attractive to liquidity, both in terms of itself and the additional consequences it brings.
Options trading provides more liquidity for the underlying asset as options market makers engage in dynamic hedging strategies. The continuous buying and selling by options traders provides a stable flow of trades, smoothes price fluctuations, and increases overall market liquidity, allowing for a larger pool of funds to enter the market while reducing slippage.
The approval of IBIT options may also attract more institutional investors, especially those managing large portfolios, as they typically 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 can invest in Bitcoin volatility, considering that Bitcoin itself has higher volatility than other assets, which may bring substantial returns.
Bitcoin annual realized volatility:
Eric Balchunas, an analyst at Bloomberg, pointed out that the approval of options is a major victory for Bitcoin ETFs as it brings deeper liquidity and attracts “larger players”.
Meanwhile, the approval of IBIT options is another clear statement from regulators. Mike Novogratz, CEO of Galaxy Digital, stated in a CNBC interview, “Unlike traditional Bitcoin futures ETFs, these options allow for 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 could 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 growth of CME options liquidity will be most evident as both markets cater to traditional investors, and the arbitrage opportunities formed between them will increase the liquidity of both markets simultaneously.
Varied price performances
The introduction of options not only brings more diversified trading opportunities for investors but also comes with previously unforeseen price performances.
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 often highly concentrated. If many people buy options with a $65,000 execution price for Bitcoin, typically, as a result of traders hedging their risk at that level, the traders would buy when the price is below $65,000 and sell when the price is higher, keeping the Bitcoin price pinned to the strike price.
If there is some kind of trend, it usually lags behind until after the options expire for various reasons. 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 because it marks the evaluation of hedge fund performance and the buying and selling of shares, creating inflows of funds and buying pressure. Due to all these dynamics, there is indeed post-expiration volatility in the spot market, as perhaps the hedging activity of many traders weakens after expiration.
Options do not trade over the weekend, and a high gamma value on IBIT at Friday’s market close may force traders to buy Bitcoin spot over the weekend to hedge their delta. There may be some risk in transferring Bitcoin to IBIT because it is cash-settled. All these risks could ultimately spread to the Bitcoin market, and we may see wider bid-ask spreads.
Conclusion
For institutions, Bitcoin ETF options can 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 multifunctionality of options may also trigger bullish sentiment in the market classic reflexivity, and liquidity brings more liquidity. However, whether options can effectively attract funds, have sufficient liquidity, and form a positive feedback loop to attract funds still needs to be validated by the market.
