Bitcoin

Survive the volatility of cryptocurrency with derivative contracts

Volatility has been the dominant issue on the financial markets lately. As uncertainty about COVID-19 and its economic impact deepens, markets fluctuate wildly. We have seen the SP 500 fall off a cliff and risky assets in general have been hit. Cryptocurrency markets were no different and showed extreme volatility. Amid pessimism, Bitcoin (BTC) fell below the $ 4,000 mark on Black Thursday, falling nearly 50% from its recent highs.

More than a month has passed since the decline, and although prices have recovered sharply, sentiment hasn’t improved. There is still some fear among traders and they are still aggressive. These abrupt moves damage market confidence and it will take some time for traders to feel comfortable taking the risk again overnight.

It is difficult to say how long it will take for markets to recover and the real impact of the current crisis to become apparent.. Some estimates assume that it will take 12 to 18 months for the global economy and markets to fully overcome this shock. In this context, it can rightly be said that the markets should remain restless for some time and that volatility continues.

Volatile markets increase the directional risk

Survive the volatility of cryptocurrency with derivative contracts
Survive the volatility of cryptocurrency with derivative contracts

The extreme volatility of the markets is a problem for traders who are on the wrong side of price fluctuations. On March 12, the price of Bitcoin fell more than 40% and a 16% the next day. More than $ 750 million in positions they were liquidated in the middle of these vibrations.

The implied volatility of Bitcoin it rose to 250% a year in March and although it has cooled to around 70%, it is still quite high. Performing directional operations under such volatile market conditions is very risky. The higher the volatility, the greater the directional risk for traders. If traders do not maintain a sufficient margin in their positions, there is a possibility that they will be caught and liquidated in a price range. Violent price fluctuations have been an integral part since Black Thursday. This has made directional trade difficult not only for new traders, but also for veterans.

Isolate the directional risk from the volatility risk

In calm market conditions, traders try to profit by using the dynamics of the market direction. If they correctly predict the direction of the market, they will make a profit. If the market moves against you, there will also be losses. The amount by which a trader’s portfolio is affected by the unit price movement is called “delta“A measure of directional risk. There is another risk to a trader’s portfolio that most traders tend to ignore in calm market conditions: the risk that the price will fluctuate up and down as it moves. Shifts in a certain direction. This Risk to a trader’s portfolio is called “Vega“” and measures the risk against changes in volatility.

Just as traders use futures contracts to position themselves against the directional risk, options are useful to protect themselves against rising or falling market volatility. Traders can also use options to remove all or part of the directional risk from their portfolios and only rely on market volatility.

Some exchanges are at the forefront of innovation in this regard, offering products that allow traders to trade at risk of volatility without taking a directional risk. If an operator believes the market will remain volatile, they can buy volatility without being exposed to the effects of the direction of the market.

Growth of the cryptocurrency options segment

When the markets for crypto derivatives mature We see more and more traders participate in the options markets and in the volatility of trading. In traditional markets such as the stock markets, the volume of option contracts can be a multiple of the volume of futures contracts. Although cryptocurrency options markets have been around for a few years, volume has been increasing slowly.

Options trading is considered by most cryptocurrency traders to be difficult to understand and intimidating. The options must be packaged so that merchants can easily understand the payment profile without having to deal with the matter. This would help reduce friction and increase demand for cryptocurrency options trading. A MOVE contract is one of these products. In this case, the dealer has an option: A multi-legged option position that benefits from the highest volatility on the market regardless of the market direction.

The straddle strategy, simplified

One way of volatility is to buy a platform. A straddle is nothing more than a combined call and put option. Therefore, you can create a long position on both sides by buying a call option and a put option that have the same price for execution and process. When the market rises, the call option becomes profitable. When the market falls, the put option starts to become profitable. Creating an intermediate position itself can be complex for dealers. Not only do you need to find liquidity in both the call and put options, you also need to process both trades at the same time.

MOVE contracts are nothing more than a package of “straddle” positions. Therefore, when a trader buys a MOVE contract, they are essentially buying a call option and a put option with the same trade and quantity.

The crypto equivalent to trading with the VIX

The Cboe has an index called the Volatility Index or VIX, translated into Spanish as the Volatility Index, which is also known as the fear index. The reason why the VIX is called the fear index is because its value rises when the uncertainty or fear of the market is high, and falls when the market is calm. Investors cannot invest directly in the VIX, but they can bet that the VIX will go up or down by trading futures on the VIX or buying VIX-related products such as VIX futures exchange traded funds. On cryptocurrency markets, trading MOVE contracts is the same as trading VIX products as investors are exposed to the volatility of cryptocurrencies only.

Eliminate currency settlement risk

Another important aspect of a derivative product is the settlement currency, ie the currency in which the final profit or loss is realized. The default billing currency for most crypto derivatives is Bitcoin. This is understandable, since stable coins were not common at the beginning of the crypto-derivative ecosystem. For this reason, products were innovated that enabled billing in Bitcoin or other cryptocurrencies. This was partly due to customer demand as retailers focused on increasing their number of bitcoins. Things have changed a lot over the past 12 months, and we’ve seen strong demand for stable coin liquidation in the crypto derivatives segment.

Gold futures, stablecoin futures and the growing demand for stable assets

Another way to combat a volatile market is to switch to low-risk assets like gold. Gold-backed currency futures offer cryptocurrency traders the ability to protect the value of their portfolios in times of widespread uncertainty. These derivatives have also opened up a new trading sector that allows cryptocurrency traders to access physical gold. Due to the recent surge in gold prices related to the corona virus threat and the liquidation of world markets, they were in high demand on many futures exchanges.

Futures contracts on stablecoins are also becoming more popular as traders have arbitrage opportunities to benefit from a stable token while taking minimal risk. Overall, given the fears of an economic downturn, the industry has seen increased demand for a stable digital currency and will continue to rely on stable coins as a safe haven.

Last thoughts

Derivatives offer traders a form of protection in times of high market uncertaintyThey isolate and protect against various types of risk and help determine real prices. In the long term, a healthy derivatives market helps reduce the long-term volatility of an asset class.

The crypto derivatives segment has seen tremendous growth in the past two years, but so far we’ve only scratched the surface. For mature assets Derivatives markets are four to five times larger than spot markets. Bitcoin’s perpetual swaps currently make up the majority of the crypto derivatives segment. As the markets for crypto derivatives grow, the demand for futures on currencies other than Bitcoin and for options will increase, as these offer a way to control the volatility risk for traders.

The views, thoughts and opinions expressed here are only those of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.

This article does not contain any investment recommendations or recommendations. Every step of investment and trading involves risks. You have to do your own research when making a decision.

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