Crypto Options Traders Bet Against Volatility

• Bitcoin's (BTC) key volatility metrics are hovering at multiyear lows, suggesting the potential for a move higher back toward the mean.
• Some traders, however, are saying the initial optimism around the set of applications for spot exchange-traded funds has faded and options look pricier.
• Shorting volatility through options is a risky strategy and requires active management of the position.

There is a lot of market chatter about an impending volatility explosion in bitcoin. Still, some crypto traders retain a bias for shorting volatility — that is setting up strategies that bet against price turbulence.

Bitcoin, the leading cryptocurrency by market value, has primarily traded in the range of $29,000 to $30,000 since July 24. That's below the $30,000-$32,000 range of the preceding four weeks. The cryptocurrency's price hasn't risen more than 4% in a single day since June 21.

As such, key metrics gauging bitcoin's backward-looking realized volatility and estimated or implied volatility have tanked to multiyear lows.

Because volatility is said to be mean-reverting, and because increased volatility boosts options prices, some market participants are anticipating sudden and notable price turbulence and are considering buying BTC call or put options, which offer protection against bullish or bearish moves, to profit from the change. That's known as the "long volatility trade."

Others, including Greg Magadini, director of derivatives at Amberdata, suggest considering a short trade.

"Upside volatility likely remains far away unless BTC can take new year-to-date highs. The clearest catalyst for this currently revolves around a BTC spot ETF," Magadini said in his latest market note. "I continue to believe the 'base case' in this environment is to lean towards the short-vol bias, (in the near term)."

Traders typically short volatility by selling or writing call or put options. The strategy is preferred when realized and implied volatility metrics appear rich relative to their historical standards or lifetime average, there is a lack of catalysts for price moves, and implied volatility is greater than realized volatility.

Currently, realized volatility, or RV, and implied volatility, or IV, are hovering at multiyear lows, which doesn't favor selling options or shorting volatility. However, the other two factors do.

The initial optimism from the string of U.S. spot-ETF filings by the likes of BlackRock, Invesco and others in mid-June has faded, and the Securities and Exchange Commission's final decision on the matter is months away. Bitcoin's 30-day options-based implied volatility stood at an annualized 29.5% at press time with the realized volatility was 25%, according to Amberdata. The seven-day IV also traded at a premium to the equivalent realized volatility. Those readings indicate near-term options aren't necessarily cheap.

"There's a lot of cost (carry) for long volatility players assuming nothing happens until an ETF decision. Realized continues to be dismal, as the spot is trading in tight daily ranges," Magadini wrote. "The fundamental catalyst for volatility, the ETF, is ways away."

Griffin Ardern, a volatility trader from the crypto asset-management firm Blofin, expressed a similar view, saying that selling volatility is one of the few profitable trading strategies.

"The implied price-moving range of the current 7-day average IV is about 4% for BTC. Still, the realized daily price moving range is less than 1%, or even less than 0.5%, which means that selling volatility will have relatively good returns, although the current IVs are also at historically low levels," Ardern told CoinDesk. "Given the absence of big news in August, selling volatility and taking a vacation for solid theta gains is the only thing I can do right now."

Theta gains equal to selling time for a short options seller. As time passes and expiration nears, the option becomes cheaper, yielding a profit for the option seller.

Hedging risks

Shorting volatility or selling options is a risky business, which can result in huge losses if the market moves suddenly. It requires an ample supply of capital and expertise.

One way to mitigate the risk involved is to purchase out-of-the-money options if and when the market moves, Magadini said.

Calls at strike prices above the underlying security's going market rate and puts below the going price are said to be out of the money, and are popularly referred to as wings or tails.

"A move above $32,000 could bring both a bullish spot trend and an explosion in volatility with it. Buying long-term out-of-the-money call 'tails' is an interesting way to hedge a short-vol (near/medium term maturity) play," Magadini said.