Deribit, Bitcoin Options and Volatility

Flood @ThinkingUSD
Jun 7, 2018 · 8 min read

A Brief Introduction to Options:

For those unfamiliar with options, there are two types of options: Call options and put options.

Calls give the option holder the right, but not the obligation, to buy the underlying security at the strike price.

Put options give the option buyer the right, but not the obligation, to sell the underlying security at the strike price on or before the expiration date.

You would buy a call option if you are bullish on the underlying, and buy a put option if you were bearish. The cost or price of an option is called the ‘option premium’.

There are two entities involved in an option contract, the buyer and the seller (or writer). When you “sell” (or “write”) an option you receive the option premium that the buyer is paying.

Each option has a price which can be bought or sold, and which fluctuates depending on the probability if the option will in-the-money (ITM) or out-of-the-money (OTM) at expiry. If you option is OTM, you will receive nothing. If your option expires ITM you can calculate your profit in the following manner:

Call Option Profit:

(Price of BTC upon expiry — Strike Price) — (Option Premium Paid)

Put Option Profit:

(Strike Price — Price of BTC upon expiry) — (Option Premium Paid)

The most important variable determining the option premium is the so called Implied Volatility (or ‘IV’). This is the market’s expectation of the severity of price movements over life of the option. The higher the IV, the higher the option premium.

Options provide ways of trading (or in this market, speculating) with defined risk:

· Option buyers can benefit from price movements and know they can not lose more than the premium,

· Option sellers receive the premium and can determine exactly what their risk profile is.

I’ll be providing a more in depth breakdown of the different types of options and strategies for trading options in a later guide.

Now onto the Review:

Since Bitcoin and crypto currencies in general are relatively new markets, it’s not surprising that there is a lack of working infrastructure for speculating on the price of Bitcoin. Spot exchanges are great for the average trader, more experienced traders will find there is an absence of professional trading platforms.

This is especially true when it comes to trading Bitcoin options, as you don’t have many choices. Unless you’re willing to park a considerable amount of Fiat into a “know your customer” (KYC) exchange like CBOE or LedgerX your options are limited. If you want to trade on a crypto exchange you can attempt to trade BitMEX’s options, but I’d highly recommend against doing so. These options are extraordinarily overpriced when compared to Deribit’s, which have been trading 5 to 10x cheaper on exactly the same contracts. You also cannot be net short on BitMEX’s option contracts, meaning you’re not able to sell the hugely overpriced options.

Deribit is a Bitcoin derivatives exchange based in Amsterdam with servers located in Strasbourg, France. Deribit provides the most accessible platform for trading Bitcoin derivatives. Their trading platform UI is easily navigable and even displays your combined Delta Total, making it easy to assess directional risk across your entire portfolio when trading Deribit’s options and futures products.

Deribit’s futures products currently offer up to 50x leverage, although you should not be trading with anything high leverage to begin with. Deirbit is currently offering Quarterly Futures contracts with a Bitcoin index consistenting of Bitfinex, GDAX, Bitstamp, Gemini, Itbit, and Kraken. While they are less liquid than BitMEX, they never have any overload issues. Each contract is worth 10 dollars (USD).

Deribit’s unique selling point for most traders are their option products. They are the only exchange that offers a wide range of liquid options with fair prices, since people (not just an in house market maker) are allowed to sell the options. Calculations like break even price, profit/loss, and risk calculations are simple, since each option contract is the equivalent of one Bitcoin. Deribit currently offers a wide range of options, including Weekly, Monthly and Quarterly Options. The furthest out option contracts they offer is the recently launched six month contract.

All positions are margined in Bitcoin, and they are “cash settled” meaning there is no transfer of assets, but you will be paid or debited in Bitcoin. This makes P&L and margin very simple when trading their derivatives products.

If you’re interested in all the specifics of the Deribit platform they have a fantastic documentation section on their website.

Volatility and Options

If you’ve been paying attention to the CryptoCurrency market, you will have noticed that Volatility has been steadily decreasing since the beginning of this year. Annualized Historical Volatility for BitMEX’s .BXBT Index according to 30 minute Time Weighted Average Price (TWAP) is down over 66% Year to Date (YTD). This means that Bitcoin’s price has been less likely to fluctuate at the levels we saw in Q4 of 2017 and the beginning of Q1 of 2018.

Here’s a graph of the 48-hour Rolling IV of the most liquid Deribit options and Bitcoin Price:

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This is actually the first graph of Bitcoin implied volatility ever to be published.

As exhibited by the graph above, Volatility was highly variable up to December 2017 as the market was gaining liquidity and experience. In December 2017, Implied Volatility (IV) went up together with the BTC price, and it stayed relatively high until the end of March 2018. As option premiums rise with volatility, this was a great period to sell volatility (write options and collect the premium).

After the end of March, volatility started to decline and has now reached a historical low. This means it might now be a good time to buy volatility (purchase options). Call options might be especially interesting (if you’re bullish) because unlike traditional markets where IV typically rises when the market goes down, Bitcoin’s IV tends to go up when the price of BTC rises. This might generate a double boost to a call option price if BTC goes up.

If you are bullish on Bitcoin short-term, a very simple way to take directional trade on Bitcoin with defined risk would be to buy some short dated call options. These seem quite cheap because of the historically low IV. Below are calls with 29th of June expirations (June 7th prices 10:47 CET, strikes on right hand side):

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Breakevens are simple to calculate for these calls since they give you the right to buy one Bitcoin at each respective strike price. For the 8000 strike call option the break even price would be 8375.10. For the 8500 strike call option, 8720.42 would be the break even price. If the price of Bitcoin fails to reach either of the strike prices, you will lose the premium you paid to purchase the option.

Here is a comparison of the P&L profile at different BTC prices at expiration for BitMEX options vs Deribit options.

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This graph shows the P&L profile of the Bitmex UP contract versus the exact same option contract traded at Deribit (June 1 prices). As you can see Deribit’s option product is superior in P&L at any BTC level at expiration. The reason for this is that the only party allowed to sell the Bitmex UP contract is Bitmex while the Deribit options are traded freely. At exactly the same point in time the contract at Deribit is about 4.6x cheaper and this makes it a lot more attractive for call buyers.

Speaking with their COO, Lennard Zwart, he was kind enough to answer a few of my questions:

What are your plans for improving liquidity?

Option liquidity is already very good after improving a lot over the last few months, most options feature a tight bid-ask which is improving all the time. There is also more liquidity than you think when first looking at the order book. If you hit the bid with a large size you will usually get filled at that level after a while or with a small improvement.

We have a number of very good market makers on the platform already and are talking to several large liquidity providers rabout joining.

Our roadmap also features the introduction of various new products and possibilities that we expect to drive volume. The December options that we launched last week are only teaser in that respect. We have also done almost nothing on the marketing so far. Going forward are going to ‘spread our message’ in a very serious manner.

Do you market make on your own platform?

No, we stopped doing this in November as autonomous market making improved and we are not going to do this again.

What are the benefits that you offer over other exchanges?

* Fastest API: 200 requests/ps rate limit and no access problems whatsoever when the market is moving

* Trust: no preferential access for anyone (like we are seeing on other exchanges with access problems)

* Only liquid option exchange

* Portfolio margin option that allows everybody to trade professionally

* Fair margining mechanics

On the margining mechanics: If your trade goes into the money you can keep your leverage constant and use your P&L to increase the size of your trades. We also don’t keep all the money that is used for maintenance margin when there is a closeout but you get any money back which is left over. We also execute partial liquidations to try and bring the margin back into compliance instead of closing out customers in one go.

When do you plan to have compatibility with Yubikey?

We will do this but not with urgency as we have a lot of important new products planned already (Trezor and Ledger login will be possible as well)

How do withdraws from your exchange get processed?

We have a small hot wallet with 1% of funds, the rest resides in a cold wallet in a bank safe. If the funds in the hot wallet not enough we get them from the cold wallet, this takes max 24 hours. 98% of withdrawals are instant from the hot wallet

This should cover the basics of the Deribit platform and why I believe the platform boasts advantages over other similar trading platforms. Deribit offers a wide range of derivatives products which are simple to understand and trade. Once liquidity improves I would imagine that this exchange will become one of the Top 5 CryptoCurrency exchanges.

If you’re interested in trading on Deribit feel free to sign up using this link (no KYC required):

Additionally if you have any question feel free to DM or tweet me at:

Deribit also has it’s own telegram where you can ask their staff about any question regarding their exchange:

New Deribit developments can be followed on their twitter account:

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