Bitcoin derivatives witnessed a major expiry event with a notional value of over $1 billion. Today, $272 million of Bitcoin futures expired on the Chicago Mercantile Exchange, while over 65,000 Bitcoin options contracts expired across Deribit, CME and OKEx, having a notional value of over $740 million.
Usually, major expiry events bring about a considerable change in volatility and price that can be seen through derivatives volumes, open interest and even put/call ratios. The Bitcoin (BTC) derivatives market, consisting mainly of Bitcoin futures and options, has grown multifold in 2020. This growth has seen the relationship between BTC’s price and the derivatives market deepen.
Price implications and maximum pain
Prior to expiry, around 60% of the options set for expiry were said to be “out of the money,” which means that 60% of these options have a strike price higher than the market price of Bitcoin. This reduces the chances of major volatility of the underlying asset, as it doesn’t make sense for these options to be exercised at higher than market prices.
While if these options would mostly be “in the money,” it would entail that their strike price would be lower than the market price, making it lucrative for the investors, thus increasing volatility.
Another indicator of expected volatility implications of a major expiry event in the derivatives market would be the concept of the maximum pain theory, which is a calculation methodology that shows the price level at which option buyers would suffer the greatest amount of financial losses. It’s an excellent metric to gauge price implications, as it reflects all the open interest for a particular expiry date and does not reflect any specific investor’s portfolio. Luuk Strijers, the chief commercial officer of Deribit, discussed the expiration with Cryptox, stating:
“Looking at max pain, it indicates that no big impact is to be expected if BTC expires within a USD 9K–12K range. Some are hypothesizing that the August monthly calls that have flipped to ‘in the money’ from the large upward move in the last month can cause momentary price distortions in the futures, as counterparts hedge their deltas differently during the settlement period.”
As expected, Bitcoin was well within that range post expiry of the derivatives, rising from $11,367 at expiry to around $11,500, which is a critical resistance level. This is indicative that the bullish sentiment in the market continues to hold among investors post expiry. Average options volumes were observed on Deribit over the past day, with 17,000 options being traded
Futures and options open interest show opposite trends
Open interest is the number of outstanding futures/options in the market at the end of each trading day. It’s often indicative of the market sentiment and the significance of the price trends noticed. According to data from Skew, leading up to this major expiry event, open interest for options has a positive trend while that for futures has a negative trend. This trend is noticed in OI for the Chicago Mercantile Exchange.
Open interest for Bitcoin options hit their all-time high at $2.1 billion on July 31, after which OI declined in August before hitting $2 billion again on Aug. 20, continuing holding this level until the expiry date. While high open interest is usually perceived to be a sign that markets can lean toward being bullish or bearish, Jay Hao, the CEO of cryptocurrency exchange OKEx, told Cryptox:
“A bearish market on Bitcoin will not reduce the amount of OI. On the contrary, the stronger the sentiment of bearishness or bullishness, the stronger the demand for trader transactions, which may increase OI.”
A factor that boosted the open interest of BTC options may be the fact that Deribit, the crypto derivatives market leader, slashed its expiry fees for this major expiry event. Strijers confirmed the sentiment by saying: “Deribit has reduced expiry fees by 25% of which the effect will become clearly visible for all holders of OI this Friday.”
Futures or options — The significance of their expiry
Since the options market is deeply related to how the futures are priced, it’s undeniable that these markets are correlated. As this end of month expiry was significant in terms of size for both futures and options, it would be interesting to note which one had a larger impact on the price and volatility of BTC. The simplicity of futures, when compared to a complex financial product like options, becomes the main feature of this subject, according to Hao:
“At present, the implication of futures expiry is more prominent than options delivery because, in general, users understand futures better than options. At present, the main participants in options are institutional traders. The number of participants, trading volume and liquidity in the options market are far smaller than futures.”
Although, this phenomenon is subject to change as the crypto derivatives market grows and the institutional interest piques further. According to Hao: “As the derivatives market matures, we believe that more experienced investors will participate in the options market.”
Benefactors and the impact on the market
Even though the price implications of this expiry event were not drastic, there are investors who benefited from this expiry. Cryptox discussed this further with Shaun Fernando, the head of risk and product strategy at Deribit, who spoke of the positions options that investors held to make profits during this expiry: “Short BTC option holders benefitted, as Bitcoin didn’t cross the 11,250 nor 11,500 strikes.” Fernando elaborated further on the activity in the futures:
“Despite low volatility in the index during the settlement period, there was a lot of activity in the futures (including perpetual), as large numbers of deltas had to be traded.”
When compared to the traditional futures market, where the delivery of futures contracts requires liquidation and/or shifting of the underlying asset, creating a huge opportunity for arbitrage, for BTC futures, the arbitrage opportunity doesn’t exist due to the digitized nature of the asset. Another big differentiator is the difference in volume between the futures market and the spot market. While the futures market is several times larger than the spot market in traditional markets, for Bitcoin, the size of the futures market is very small in comparison. Hao discussed this reduced impact in Bitcoin futures markets, elaborating: “Although the derivatives market in the crypto space has been relatively prosperous, the number of users who really participate in arbitrage is not very large, so this tidal effect is not very obvious.”
However, the size of derivatives markets continues to impact the Bitcoin spot market, as seen in the case of Ether derivatives where Ether (ETH) options have seen phenomenal growth in 2020 on the back of anticipation of the network upgrade to Ethereum 2.0. Hao echoed this analogy:
“The spot price affects the price of futures (including futures and options). We can prove this by looking at the ETH options market. The bullish sentiment on ETH in the entire market a while ago was very strong, and this sentiment led to an increase in ETH spot prices.”
This expiry event may not have had major immediate price implications, but it increasingly stresses the importance of the growth of the Bitcoin derivatives market and the need for investors to further their understanding of the same in order to benefit from such events.
