Crypto Traders Find Ether Options Attractive as 'Implied Volatility' Slides

It makes sense to buy options as volatility is so low, one observer said.

AccessTimeIconApr 22, 2022 at 9:48 a.m. UTC
Updated May 11, 2023 at 5:27 p.m. UTC
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The ether (ETH) spot market lull has traders focusing on derivatives, with some finding options cheaper in this low implied volatility environment.

Barring a brief spike to $3,200 early this week, ether, the second-largest cryptocurrency by market value, has mostly traded in the range of $2,400 to $3,200 since late January.

The combination of directionless price action and explosive growth of the decentralized finance option vaults has pushed ether's three-month daily implied volatility (IV) or expectations for price turbulence to 3.5%, the lowest since November 2020, according to data provided by Skew.

The implied volatility is undervalued compared to its lifetime average of 4.9%, but it is also significantly cheap compared to the three-month daily historical volatility, currently at 4.1%. The spread between the historical volatility and implied volatility is the widest it has been since July 2021.

In other words, options, both call and put, are cheap. Implied volatility is one of the critical factors determining the prices of options, which are derivative contracts that give the purchaser the right but not the obligation to buy or sell an underlying asset at a predetermined price on or before a specific date. A call option gives the right to buy, while a put offers the right to sell.

"In my opinion, it makes sense to buy options [call and put] given volatility is low," Samneet Chepal, quantitative analyst at the digital asset investment firm LedgerPrime told CoinDesk in a Telegram chat. "The IV is quite cheap largely due to the choppy market action, which results in traders being more complacent in selling vol plus the impact of systematic selling from the DeFi option vaults."

Ether: Three-month implied and realized volatilities (Skew)
Ether: Three-month implied and realized volatilities (Skew)

Buying options – call and put – tracking cheap implied volatility essentially means taking a long position on volatility. It's a direction-neutral bet that would make money as long as there are price swings. The implied volatility is mean-reverting and positively impacts the option's price.

While spot and futures markets allow traders to take directional bets, options open an additional dimension of volatility trading. However, it's not without risks. For example, the implied volatility can stay cheap for a prolonged period before bouncing to the mean, and options lose money as the time for expiration nears. It's called theta decay in options parlance. So, traders buying volatility via long call/put positions can lose money if the expected bump up in implied volatility doesn't materialize before expiration.

"While options look cheap, there's a risk that we continue seeing choppy price action for some time hence resulting in the [options] premium being decayed," Chepal said, adding that selling a strategy called a reverse iron condor could mitigate risk associated with continued low-volatility sideways price action.

The reverse iron condor is a four-part strategy established for net debit. Both the potential profit and maximum risk are limited, as seen below.

Payoff diagram for a hypothetical reverse iron condor trade.
Payoff diagram for a hypothetical reverse iron condor trade.

"One alternative might be to sell iron condors which can result in lower theta decay in the case vol continues staying low," Chepal said.

Griffin Ardern, a volatility trader at crypto asset management firm Blofin, said, "the whole of April is a relatively good time to bet on volatility [with calls and puts], but right now, it's preferable to use a combination of call options to go long on volatility. That's because puts appear relatively overpriced."

Indeed, put-call skews, which measure the cost of puts relative to calls, show puts are drawing a higher price than calls across all time frames, including the six-month expiry. Traders have been buying outs off late. "We've also seen large demand for low delta [lower strike] puts, particularly in ETH, across the expiries out till December with strikes as low as 1,000. This could also be a play on further delays with the ETH Merge," Singapore-based QCP Capital said in a Telegram broadcast.

Ardern cited a combination of call ratio spread – buy a call near the spot price and sell two at a higher level – and a short futures position as a preferred strategy. "If IV rises and the market falls, you will get a higher profit for a relatively less cost," Ardern said. "Compared with buying strangles, the cost of building this strategy can be relatively lower while achieving similar benefits."

Straddles and strangles are widely used to profit from an impending volatility spike. These strategies involve buying the same expiry call and put options in equal numbers.

Options trading is far more complex than trading in the spot market or buying/selling futures. Before setting up a position, seasoned traders study the so-called option greeks like delta, gamma, theta and vega. This can be a daunting task to the uninitiated and dabbling with options without the necessary know-how can lead to significant losses.

Correction (13:26 UTC): LedgerPrime's Samneet Chepal cited the reverse iron condor option strategy as a better alternative to outright call and put option buys. The previous version of the article erroneously mentioned short iron condor as the preferred strategy and carried the wrong payoff diagram.


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Omkar Godbole

Omkar Godbole is a Co-Managing Editor on CoinDesk's Markets team.

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