Original author: Mensh, ChainCatcher

Original editor: Nianqing, ChainCatcher

On October 18, the U.S. Securities and Exchange Commission approved applications from the New York Stock Exchange (NYSE) and the Chicago Board Options Exchange (CBOE), allowing 11 approved Bitcoin ETF providers to engage in options trading. Currently, Bitcoin continues to rise, with highs surpassing $69,000.

ETF analyst Seyffart stated at the Permissionless conference that Bitcoin ETF options may launch by the end of the year, but the CFTC and OCC do not have strict deadlines, so further delays are possible, with more likelihood of launching in Q1 2025.

At the same time, the SEC delayed the approval of Bitwise and Grayscale Ethereum ETF options, with the market speculating that this is due to the inflow of funds being less than expected after the Ethereum ETF approval. The SEC hopes to further investigate the impact of this proposal on market stability and will make a ruling on November 10.

Bitcoin and Ethereum ETF inflows and outflows:

Why are Bitcoin ETF options important?

Bitcoin options are contracts that grant the holder the right, but not the obligation, to buy or sell Bitcoin at a predetermined price within a certain timeframe. For institutional investors, these options provide a means to hedge against price volatility or speculate on market trends without holding the underlying asset. These Bitcoin index options offer institutional investors and traders a quick and cost-effective way to expand their investment exposure to Bitcoin, providing an alternative method to hedge their exposure to the world’s largest cryptocurrency.

Why is the approval of Bitcoin ETF options particularly important? Although there are already many crypto options products on the market, most of them lack regulation, making institutional investors reluctant to participate due to compliance requirements. Additionally, there have been no compliant and liquid options products available in the market.

The most liquid options products are launched by Deribit, the largest Bitcoin options exchange in the world. Deribit supports 24/7/365 trading of Bitcoin and Ethereum options. The options are European-style, settled in physical underlying cryptocurrency. However, since it is limited to cryptocurrency, Deribit users cannot cross-margin assets with traditional portfolios like ETFs and stocks. Additionally, it is illegal in many countries, including the United States. Without the backing of a settlement institution, counterparty risk can never be effectively resolved.

The Bitcoin futures options at the CME and the Bitcoin options at the CFTC-regulated crypto options exchange LedgerX have very large bid-ask spreads. They have limited functionality, such as LedgerX lacking a margin mechanism. Each call option on LedgerX must be sold in a cash form (owning the underlying Bitcoin), and each put option must be sold in cash form (owning the cash value of the exercise price), resulting in high trading costs.

Options related to Bitcoin assets, such as MicroStrategy options or BITO options, have significant tracking errors.

The significant rise in MSTR stock price since the beginning of the year also indirectly indicates a demand for Bitcoin hedging trades. What Bitcoin ETF options can bring to the market is a compliant and deep trading option product. Bloomberg researcher Jeff Park noted, 'With Bitcoin options, investors can now make term-based portfolio allocations, particularly for long-term investments.'

Enhance or reduce volatility?

There is much debate about what impact the listing of Bitcoin ETF options will have on Bitcoin's volatility.

Those who believe volatility may be enhanced argue that once options are listed, many retail investors will flock to very short-term options, potentially leading to a gamma squeeze similar to that seen in meme stocks like GME and AMC. A gamma squeeze refers to a situation where accelerating volatility continues as investors buy these options, and their counterparties, large trading platforms and market makers, must continuously hedge their positions by buying stocks, further driving prices up and creating more demand for call options.

However, since there are only 21 million Bitcoins, Bitcoin is absolutely scarce. If IBIT experiences gamma squeeze, the only sellers will be those who already own Bitcoin and are willing to trade it at a higher dollar price. Everyone knows that no more Bitcoins will be issued to drive prices down, so these sellers will also choose not to sell. The listed options products also have not experienced gamma squeeze, perhaps indicating that such concerns are unnecessary.

The concentration of options expiration can also cause market volatility in the short term. Deribit CEO Luuk Strijers stated that the open interest of Bitcoin options expiring at the end of September is the second largest in history, with approximately $58 billion in open interest currently on Deribit. He believes that this expiration may see over $5.8 billion in options become worthless, which may trigger significant market volatility after expiration.

https://www.coinglass.com/options

Historically, options expiration has indeed affected market volatility. As the expiration date of options approaches, traders must decide whether to exercise the options, let them expire, or adjust their positions, which typically increases trading activity as traders attempt to hedge their bets or exploit potential price changes. Especially if Bitcoin's price is near the strike price at the time of expiration, option holders may exercise their options, which could lead to significant buying and selling pressure in the market. This pressure may trigger price volatility after the options expiration.

Those who believe volatility will flatten are looking more from a long-term perspective. This is because the option prices reflect implied volatility, which is investors' expectations for future volatility. IBIT brings new liquidity, attracting more structured notes issuance, which could lead to potential volatility reduction, as if implied volatility is too high, more options products will enter the market to flatten it.

Larger funds attract bigger fish

The launch of options will further attract liquidity, and the trading convenience brought by liquidity will further attract liquidity, forming a positive cycle of liquidity. Currently, the market consensus almost agrees that the launch of options, whether from themselves or the additional consequences they bring, has an attractive effect on liquidity.

As options market makers participate in dynamic hedging strategies, options create more liquidity for the underlying asset. This continuous buying and selling by options traders provides a stable flow of trades, smooths price fluctuations, and increases overall market liquidity, allowing larger pools of capital to enter the market while reducing slippage.

The launch of IBIT options may also attract more institutional investors, especially those managing large portfolios, as they often require complex tools to hedge their positions. This capability lowers the perceived risk barrier and allows more capital to flow into the market.

Many institutional investors manage large portfolios with very specific requirements for risk management, purchasing power, and leverage. Spot ETFs alone cannot solve the problem. Options can create very complex structured products that allow more institutional capital to participate in Bitcoin.

With the approval of IBIT options, investors can invest in Bitcoin's volatility, considering that Bitcoin's volatility is higher than other assets, which may yield substantial returns.

Annual realized volatility of Bitcoin:

Bloomberg analyst Eric Balchunas pointed out that the approval of options is a major victory for Bitcoin ETFs, as it will bring deeper liquidity while attracting 'bigger fish'.

At the same time, the approval of IBIT options is another clear statement from regulators. Mike Novogratz, CEO of Galaxy Digital, stated in a CNBC interview that 'unlike traditional Bitcoin futures ETFs, these options allow for trading at specific intervals, which may attract more capital interest due to Bitcoin's inherent volatility. The approval of ETF options may attract more investors. The trading volume of MicroStrategy reflects strong demand for Bitcoin. The clarity of regulation may pave the way for the future growth of digital assets.'

For the existing options market, the approval of ETF options will also bring greater gains. In an Unchained podcast, Joshua Lim, co-founder of Arbelos Markets, speculated that the growth of liquidity in CME options will be most evident, as both face traditional investors, which will simultaneously increase the arbitrage opportunities and liquidity in both markets.

Variant price performance

The launch of options not only provides investors with more diverse operational space, but it also brings previously unanticipated price performances.

For example, Joshua Lim found that many people were buying call options after the election, indicating that people are willing to make some hedging bets, believing that the regulatory environment for cryptocurrencies will ease after the election on November 5. Typically, there is some price volatility around the expiration date of these options, and this volatility is usually highly concentrated. If many people buy options with a strike price of $65,000 for Bitcoin, due to the dealers hedging their risks at this position, typically, dealers will buy when the price is below $65,000 and sell when the price is above this price, thereby pinning the Bitcoin price at the strike price.

If there is a certain trend, it usually becomes evident only after the options expiration due to various reasons. For instance, options typically expire on the last Friday of the month, but this does not necessarily align with the end of the calendar month, which is particularly important as it marks hedge funds' performance evaluations and share buy-sell activities, creating capital inflow and buying pressure in that asset class. Due to all these dynamics, the spot market does experience volatility after options expiration, as perhaps many traders' hedging activities weaken after expiration.

Options do not trade on weekends, and the high gamma value of IBIT at Friday's market close may force traders to buy Bitcoin spot over the weekend to hedge their delta. Since IBIT is cash redeemable, transferring Bitcoin to and from IBIT may carry some risks. All these risks may eventually spill over into the Bitcoin market. Wider bid-ask spreads may be observed.

Conclusion

For institutions, Bitcoin ETF options can greatly expand hedging means, allowing for more precise control over risk and returns, making more diversified portfolios possible. For retail investors, Bitcoin ETF options are a way to participate in Bitcoin's volatility. The multifunctionality of options may also spark bullish sentiment in the market's classic reflexivity, as liquidity brings more liquidity. However, whether options can effectively attract funds, possess sufficient liquidity, and create a positive cycle of attracting funds still requires market validation.