Watch Out: Bitcoin Option Traders About
Option market makers are among the most knowledgeable and highly-informed traders on any underlying. We describe some simple indices for monitoring and learning from their behaviour.
Deep out-of-the-money (OTM) put options are an insurance against a price fall. On the maturity date, which for bitcoin weekly options on Deribit could be just a few days away, one has the option to sell at a much lower price level than now. So you’ll only exercise the option if there is a crash, i.e. the market price goes below the option strike.
Otherwise, the option expires unexercised. The market maker pockets a small premium on every deep OTM put option that is bought and, usually, that’s the end of the story.
HOWEVER, when market makers see signs of an imminent crash, they stop offering these options. The market liquidity in deep OTM puts dries up. Of course, everyone wants to buy them to insure against the crash, but nobody is willing to sell them.
CryptoMarketRisk tracks the x% OTM Put-Call Ratio (PCR) with ticker x.PCR. This represents the relative volume of trades on low-strike options (OTM puts) and high-strike options (OTM calls). As x increases, the deeper OTM the options are.
The 5% and 10% OTM PCRs are shown in the figure above reported on a daily level since 1 Jan 2020. In side-ways markets one expects about the same volume on low-strike as high-strke options so this ratio should be about 1. Indeed, until the middle of Februrary it was sometimes as low as 0.25 and sometimes as high at 1.75. But basically it was fluctuating pretty regularly around 1, or perhaps a little less (because of the skew).
The Deribit options total trading volume was growing from an average of less than 10,000 contracts in January to well over 10,000 contracts in the first half of February. This is shown in grey, and is aggregated over all options traded on one day. Then something happened.
US equity markets started to nose dive. And bitcoin option market makers stopped writing OTM puts. The OTM PCR dropped below 1, quickly fell below 0.5 and stayed there until 9 March. There was a brief period when confidence in a bull period returned and the ratios peeped above 1 for a few days, but on Friday 13 March both the 5.PCR and 10.PCR indices dropped — as an all-time record daily volume of 40,000 contracts exchanged hands.
Bitcoin options market makers know what they are doing. They only write OTM puts when they expect to pocket the premium, not when they think they will get hit as the buyer of these option exercise their right to sell bitcoin above the market price.
Still, some are confident enough to write deep OTM puts again. For instance, over 2000 puts of strike 5000 and maturity 27 March 2020 were traded on Deribit on 16 March. This trader obviously forecasts a spot price of bitcoin above 5000 USD by the end of the month.
Hopefully, this is a good sign. Option traders are almost the most informed of all. Only the orchestrators of the recent, mammoth manipulative trades on Huobi futures and and BitMeX perpetuals know more. But thats another story (see our article on this).
Carol Alexander & Arben Imeraj
@CryptoMarketRisk, QFIN, University of Sussex
