The first half of 2020 was crazy for almost everyone in all asset classes. at the beginning of March When it became clear that COVID-19 was a seismic event, wealth markets around the world collapsed. That was an important reason Leveraged investors suddenly received margin calls and had to liquidate assets to satisfy them.
If the only thing that is important to someone is cash, there is no secure asset or defensive investment. During the crisis, companies rushed to access their revolving credit lines to bolster cash reserves as soon as possible and feared that if they did not do so today, these loans would not be available tomorrow. The supply of risky papers plummeted and prices began to fall. Bitcoin (BTC) and other cryptocurrencies were no different from stocks – just another asset that investors had to sell to get US dollars.
Only after the US Federal Reserve put massive amounts of cash into the banking system did the cash reserve decreaseAnd soon afterwards everyone hurried to use their money in the financial markets. The cryptocurrency markets stabilized and recovered along with the stocks. During this time, Both Bitcoin and stocks were extremely volatile, and this uncertainty was reflected in the options markets for both.
As the markets slowly began to show strength, implied volatility, measured by option prices, began to stabilize. Implied annualized one-month forward volatility reached 80% of the SP 500 stock index and peaked at 180% at BTC at the height of panic on March 16. Over the next few weeks, volatility was decreasing, although it remained high compared to historical averages.
After the madness had subsided in late March and early April, the traders turned their eyes to the next one on the horizon. For BTC, the next big thing was the next halving of mining premiums. There was much speculation on all sides about what would happen if the clock passed the fateful time of May 11th. Would prices skyrocket? Would they collide? Wouldn’t anything happen? Was everything included in the price?
Regardless of which side of the debate investors fell on, everyone could agree on one thing: halving could be a catalyst for a market move, and it might be worthwhile to have some downside protection or upside risk to take advantage of it . her. The fact that this potential event was on the horizon prevented the volatility associated with the options from dropping too quickly, even as the actual volatility began to calm down. In essence, the market seemed to agree that the options had to add value due to the uncertainty of halving. H.Towards the end of April, the implied volatility on the horizon began to increase, although the realized volatility ranged from 65% to 70% when the demand for options increased and halved immediately before, to 95%.
After the halving was over and proved to be anti-climactic, there were far fewer reasons for investors to have options, especially shorter terms. Long call and put option holders began to close their positions and sell those options to market makers, and even more of these holders opted for short positions. As market makers began to get longer short-term options, implied volatility declined aggressively.
At the same time, market makers covered their books to the best of their ability. One of the most common coverage strategies in this scenario is gamma coverage. If a position is a long option (either buy or sell, as market makers can easily hedge the sensitivity of the first order to the price of the underlying), and especially for options with an almost current date, the position has a positive gamma or positive Convexity. This means that the risk profile seems to get longer and longer as the underlying increases and shorter and shorter as the underlying falls. To offset this risk, market makers had to sell a lot of BTC each time BTC rose and to buy a lot BTC every time BTC was sold.
This gamma hedge action can lead to a positive feedback loop between implied and actual volatility. As realized volatility decreases, investors feel comfortable because they don’t expect something crazy to happen in the market soon and are more willing to sell options. As they sell more and more options, market makers accumulate long gamma positions, reducing the volatility that is contained in their pricing models. They also actively hedge this long gamma position, sell BTC when it is on the up and buy when it is down. This act of hedging the gamma without other external factors (such as big news or a large influx of investors entering or leaving cryptocurrency markets) creates a buffer effect on volatility. This cycle continues and continues to push the front of implied volatility conditions downward, while creating upside resistance and downside support for BTC prices.
We have seen that this effect has developed significantly since the end of May. The realized volatility has fallen below 30%., Despite the objectively uncertain world in which we currently live, close to multi-year lows. However, even slightly longer-term implied volatilities in the three to six month range are still trading close to the long-term historical average in the range of 60% to 70% volatility. Either the current low-volatility feedback loop environment will soon end, or some smart operations will need to be done to take advantage of the implied volatility separation in the coming months.
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.
The views, thoughts and opinions expressed here are only those of the authors and do not necessarily reflect or represent the views and opinions of Cointelegraph.
This article was written by Kristin Boggiano and Chad stone glass.