Executive summary

In this report, Rich Excell looks at recent trends in the bitcoin and ether markets and discusses a call option strategy to spread these cryptocurrencies as a way to manage potential risks.

Image 1: Bitcoin spot price daily candle chart

After almost six months of consolidation, the price of bitcoin and other cryptocurrencies has potentially broken down in the past week or so. This often prompts the question for those that follow the space: “What should I do here?” Should a trader look to trade out of the position due to falling prices? What if the trader is a HODLer? Should they ever sell?

In my years running a hedge fund, I was prompted with similar questions multiple times a year regardless of the asset class I was trading, and I had to handle different macro situations. 

In the chart above, one can see that bitcoin price has fallen and looks to be holding the one-year moving average for now, while simultaneously being in the oversold area on the RSI. Does this mean it is time to add?

Image 2: Ether spot price daily candle chart

The price of ether has also fallen and is in oversold territory on the RSI. One difference here is that it has not held the one-year moving average like bitcoin has. That said, this moving average has not defined ether as much as bitcoin. One area of support it has held is the channel it’s been in for the last six months. Given the almost doubling off the lows of last year, this current channel might be defined as a bullish flag pattern such that holding within this channel could become quite a bullish development. Does this mean one should look to add to ether instead of bitcoin? I think more perspective may be needed.

Image 3: Multi-line chart of bitcoin & ether overlaid versus offshore Chinese yuan and Japanese yen (both inverted)

A large portion of the volume of bitcoin, ether, and other coins are traded during Asian hours. Asia traders and investors have found more use cases for the coins, and the markets are often much more liquid in Asian hours. Thus, it is important to consider how Asian investors are thinking about recent moves. 

To start this discussion, I want to compare the bitcoin and ether moves to the moves we have seen in CNH (offshore Chinese yuan) and Japanese yen. The spot prices I used above were dollar prices. However, Asian traders will be looking at price in their local currencies. As I can see from the overlay chart here, the weakness seen in bitcoin and ether is matched by that seen in CNH and JPY. In fact, for the past 20 months, these products have been moving in lockstep with each other. If anything, as I look at late 2022, I can see that it moves toward stronger local currencies in China and Japan that led the move in bitcoin and ether. Now, we may be seeing the opposite, as weakness in these currencies could in fact be prompting the move lower in crypto. 

Image 4: Daily candle chart of bitcoin/yen cross

That leads me to consider what the spot price of bitcoin priced in yen may look like. As I bring up that chart, I start to see that perhaps there is a different sense of whether we are at nearby support as we saw in the bitcoin vs. dollar chart. In fact, looking at bitcoin priced in yen, I can see that it has broken through the channel that has defined the move for the past 10 months and is still well above the one-year moving average. This may suggest there is more downside to come in bitcoin/yen. 

Image 5: Daily candle chart of ether/yen cross

Using a similar analysis of the ether vs. yen cross rate, I can see that the same channel has also broken. However, when looking at the one-year moving average of the cross, I believe it is much closer to support in the short term for this cross than it is for bitcoin/yen cross. Changing the perspective of the trader has potentially given me a different opinion of what might transpire moving forward.

Image 6: Ichimoku cloud chart of bitcoin/ether cross rate

If we turn to a chart of the bitcoin/ether cross rate, I can see that this is a much more potentially bullish-looking chart. The price has entered the cloud here and appears to be looking to breakout on the upside. The lagging span has started to move higher as have the MACD. The RSI is in a relatively benign area. 

This cloud range has been falling for the better part of a year since September of last year. This has proven to be a relative weight on the bitcoin/ether cross, but I believe it may be on the cusp of seeing a change in momentum. If you're interested in exploring this relationship in the futures market, CME Group also recently launched Ether/Bitcoin Ratio futures.

Image 7: Overlay chart of bitcoin/ether cross rate and 10-year U.S. Treasury yields

If you read the last Excell with Options, I discussed the Treasury market and the issuance that is coming over the coming months. I discussed how foreign investors in China and Japan may be losing their appetite for U.S. Treasuries and how that may be a consideration for why U.S. yields are moving higher. 

If I look at U.S. yields and compare them to the bitcoin/ether cross rate over the past couple years, I see some correlation. When considering the value of any assets, I think the core approach should consider a discounted cash flow. At some level, the value of an asset is due to the cash flow you will get back from it. This may be in the short term with Treasuries, dividend-paying stocks, and corporate bonds. Or, it may be in the long term considering stocks with no earnings, artwork, and cryptocurrencies. Long-term holders of bitcoin do so because of the declining supply. The assumption here is at some point in the future, fees will be charged because there is no new issuance of bitcoin. The current value of bitcoin is then a function of these future fees or cash flow, discounted back to the current time. The same is true for ether, except it has much more current cash flow. While the staking yield may not quite approach Treasury yields, it is much higher than 0%. Holders of ether get paid to wait and so the discounted cash flow looks quite different. 

This is not to say one is better or worse than the other. Is high-growth tech better or worse than dividend-paying stocks? I think there is a time and a place for all investments. When rates are going higher, though, assets with more cash flow are often preferred. This may be why the bitcoin/ether cross rate appears to be heading higher, based on Treasury yields. If this is the case, the cross could break out above the cloud. 

Image 8: Commitment of Traders report for Bitcoin and Ether futures

The next thing I want to look at is the Commitment of Traders report for each underlying to get a sense for how levered money – CTAs, hedge funds, and the like – are thinking about the current set up. I can see from the chart above that the traders are all pretty short, with a net short position in each asset that is near the largest we have seen over the last two years. 

While I get this sense of what smart money is doing, I also know that this positioning can be kindling when there is a big move -- even if that move is on a relative basis. If there were a large move higher in ether relative to bitcoin, it isn’t unreasonable to think that these levered shorts in ether would cover and potentially move into bitcoin. 

Image 9: Implied and historical (realized) volatility for the generic front-month Bitcoin futures

Trying to get a sense if the options market is anticipating any moves or any volatility, I look to a chart of both implied and realized volatility. I can see that for the generic front-month Bitcoin future, both implied and realized have been falling for the past year, especially over the last six months or so as the asset has been in consolidation. The level of about a 40 implied volatility is near the lowest we have seen over this period. Recall when Bitcoin options often had a volatility of 100 or more?

That said, the current 40 implied volatility might actually be a little high relative to the actual movement in the futures of about a 33. There is still a reasonable spread between implied and realized that suggests that even though implied is at a low number, this doesn’t necessarily mean that it is cheap. 

Image 10: Implied and historical (realized) volatility for the generic front-month Ether futures

A similar analysis of the generic front month Ether futures shows the same pattern – a decline in both implied and realized volatility for the past year, accelerating in the last six months. Again, we are off the lowest levels of early this month, however, we are still at the lows of the year. Implied is at a premium to realized but this realized volatility has also bounced sharply in the past week or two.

Image 11: Implied volatility term structure for both Bitcoin and Ether options on futures

Looking at the term structure for the options on futures, I can see that the October period is relatively depressed for both assets. I can see that in the October period, Bitcoin implied volatility is about a 43 while Ether implied volatility is about a 37.

Looking at the implied volatility chart for the past two years above, I can see that spikes higher in implied and realized volatility often yield much higher numbers for Ether than for Bitcoin. Thus, the idea that Ether implied volatility is at a substantial discount to Bitcoin is interesting to me. 

Image 12: Bitcoin implied volatility surface

Taking a look at the implied volatility surface for Bitcoin, I can see that there is very little if any premium for out of the money options relative to the at the money options. In some ways this is not surprising to me for a product that has been seeing a strong and steady decline in implied volatility. Traders seemingly have been selling any incremental risk premia they can find. However, for a trader entering a new position, I think flat kurtosis and flat skew can present a wonderful opportunity.

Image 13: Implied volatility surface for Ether options

The same appears to be true for Ether. In fact, for many expirations, the upside options trade at a discount to the at the money options. This suggests to me there may be more flow of traders selling call options against their long underlying positions that are held for the benefit of a staking yield. Many traders may still be locked up for some time and looking to earn some incremental yield. Again, this may present an opportunity for a trader entering a new position.

Image 14: Expected return for a short October 29,000 Bitcoin call option

Now I step back and assess what all these variables mean in the current set up. First, there has been a fall technically in each individual futures price and we may or may not be near support. If I consider that traders in Asia are driving price, there seems to be more downside in Bitcoin than Ether. Second, the cross price between Ether and Bitcoin may be on the verge of breaking out after a year-long downtrend. Third, this breakout may be driven by the higher yields we are seeing in U.S. Treasuries, which are something that could continue for months to come. Fourth, leveraged traders are short both assets. Fifth, implied volatility for both assets is at the lows for the year; however, the relative spread between Ether and Bitcoin may favor Ether given the steep discount vs. the expected parity (or even premium) we often seen. Finally, the upside options in Ether trade at a discount to the at the money while in Bitcoin it is closer to parity. 

This leads me to want to play this move lower by looking at a relative call trade. I would look to sell 35 delta Bitcoin calls and use the proceeds to buy 35 delta Ether calls. In order to be dollar neutral (or close to it) on this trade, I need to buy 16 Ether calls for every one Bitcoin call I sell. 

The chart above shows the expected return for a Bitcoin call that may be quite intimidating for many traders. However, I understand that the “hedge” on the other side of this is the Ether calls I was able to buy with the proceeds from the Bitcoin call sales. 

Image 15: Expected return for long 16 Ether October 1800 calls

This chart is the other side of the trade where I use the proceeds to stay dollar neutral on my deltas and purchase 16 Ether calls for every Bitcoin call I sell. The observant trader can see from this expected return that even though I am buying multiple Ether calls, my total cost (units * quantity) is 958 where was I was able to take in 1017 to sell the Bitcoin. Thus, due to the lower volatility (I am paying a 36 implied volatility while selling a 43.50 implied volatility) allows me to take in premium even though I potentially have leverage to an upside move. 

What are my potential risks? The risk is that both assets move higher, and Bitcoin goes in the money while Ether does not. I am effectively long the cross at a rate of 0.062 (1800 / 29,000). While it dipped to that level in June of this year, it has not been there since July of 2022. In fact, the current rate of 0.064 is close to the lowest we have seen. However, this is a risk that the option I am short ends up in the money while the option I am long does not. 

What if both assets break down? If both calls finish out of the money, I would make a small amount of money because I was able to take in some on the trade (1017-958). While this isn’t a big gain, it does not hurt me. This is true even if Bitcoin holds up better than Ether on the downside and the cross falls.

What if Ether breaks out relative to Bitcoin, but it happens on a move lower in both? Again, this would be unfortunate, but I would win a small amount. What if Ether breaks out vs. Bitcoin while both assets move higher? This is the situation where I would make the most potentially given, I am long more Ether calls which would be growing in dollar value faster than the Bitcoin calls. 

Either way, the point I want to make is that when I see dislocating moves in assets, one way I take advantage without changing myr overall risk profile may be to consider relative value trades in options (calls vs. calls or puts vs. puts). This can be appealing especially for underlyings that are highly correlated. It does not always set up, but when it does, it can be rewarding. 

Stay vigilant and good luck trading!

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The opinions and statements contained in the commentary on this page do not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs. This content has been produced by [Data Resource Technology]. CME Group has not had any input into the content and neither CME Group nor its affiliates shall be responsible or liable for the same.


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