IBIT…the Hottest Option on the Planet

[00:00:01] Hello, this is Dean Curnutt and welcome to the Alpha Exchange, where we explore topics in financial markets associated with managing risk, generating return, and the deployment of capital in the alternative investment industry.

[00:00:19] Hello, Alpha Exchangers. We are rounding out 2024 and the S&P has settled into a realized vol that recently registered a six-handle.

[00:00:29] For new listeners, that translates into less than half a percent average daily move over the last month.

[00:00:36] If you've owned options during said reference period, you have, in the descriptive words of one podcast guest, died on the cross of time decay.

[00:00:45] When realized vol is six, the rent of theta is simply too damn high.

[00:00:50] My personal market lens incorporates a healthy dose of reflexivity. Prices aren't just outcomes, they are calls to action.

[00:00:58] And from this perspective, realized vol is a cause, not an effect.

[00:01:03] Realized vol of six causes just about nothing, except inaction.

[00:01:08] There may be cheap Halloween costumes overflowing the shelves at your local party city come November 1st, but you could care less. You'll wait.

[00:01:17] Similarly, market insurance may cheapen up when the S&P swings flatline, but so what? You're in no rush to spend the money on it. I get it.

[00:01:26] The quiet at the S&P, notwithstanding, other asset classes and securities are moving around, however.

[00:01:34] I count four of them in the $2 trillion valuation club that sport implied vols north of 45.

[00:01:41] That includes Tesla, Broadcom, Nvidia, and the subject of this forthcoming discussion, Bitcoin.

[00:01:48] Among these four beasts, there's $10 trillion of market cap combined value running north of 45 vol.

[00:01:57] To state the obvious, 45 vol is easy come, easy go.

[00:02:02] The former has certainly been the theme for these four.

[00:02:06] Heck, the rich go screen on Bloomberg has Elon Musk at $486 billion of personal net worth.

[00:02:15] Can Bezos even be in the same room as Musk?

[00:02:19] Not that Elon is invested in T-bills like Warren Buffett is, but the risk-free interest on his stack would be $50 million per day.

[00:02:28] And believe it or not, Tesla is the worst performer of this Fantastic Four, up just 92% in 2024.

[00:02:36] That short digression behind us lets zero in on the subject at hand, the unbelievable launch of options on IBIT, the Bitcoin ETF.

[00:02:47] What I'd like to put forth is that the financial characteristics of the underlying asset, Bitcoin,

[00:02:54] pave the way for IBIT options already off to an amazing start to become a critical industry risk management tool.

[00:03:02] Next, I want to acknowledge that while the crypto crew likes to huddle, listed options on IBIT will allow them to huddle as well.

[00:03:12] That is, hedge up digital longs.

[00:03:16] Come on, folks, you know I'm an acronym file.

[00:03:19] You may never want to sell, that's fine.

[00:03:21] But there may be times when hedging makes a tremendous amount of sense, and having this new instrument alongside your core long is a wonderful addition to the set of risk management alternatives available.

[00:03:35] Let's talk about listed option activity in IBIT so far.

[00:03:39] One month in, and the volumes are absolutely stunning.

[00:03:43] On December 16th, nearly 500,000 puts and calls traded.

[00:03:48] Citibank, a bank around for 100 years or so, and with a stock price in the same neighborhood, saw volumes less than 20% of that.

[00:03:58] The IBIT volumes are leading to substantial levels of open interest, which has just reached a shade under 2 million contracts.

[00:04:06] Why is this so important?

[00:04:08] When investors have trades that are, quote, on the books, they become arbiters of the right price, invested in understanding where a structure might trade.

[00:04:18] Two counterparties that opened a trade together are well positioned to roll it together as well.

[00:04:23] Of course, the front months are the most populated, but even out to May of 2025, there are thousands of contracts of open interest.

[00:04:32] Transactions are occurring across the strike curve, not just in at-the-money or near-the-money options.

[00:04:38] In Jan 25, there are nearly 35,000 calls of open interest with strikes above 75.

[00:04:45] These options have deltas between just 3 and 12 and are roughly 5 cents wide at vols of 80 plus.

[00:04:55] Having price discovery at these low delta points bolsters the capacity to price spreads in tail hedges.

[00:05:02] For example, when we have some sense as to where the 80 strike call may trade because the screens are two-way with posted liquidity at that strike,

[00:05:11] a counterparty asked to make a price on the 70 strike call will do so with more confidence as the 80s can be bought as part of the hedge if needed.

[00:05:21] Let's talk about posted bid offer spreads.

[00:05:36] Again, there's an ecosystem of liquidity being built here as more open interest accumulates.

[00:05:47] The pricing bots at Jane and Susk and Citadel get smarter and smarter along the way, observing where things trade, repricing second by second,

[00:05:57] and building intelligence on the relative levels of premium that populate the matrix we geeks call the vol surface.

[00:06:04] There's a virtuous cycle afoot.

[00:06:06] The launch of IBIT options comes not just during a banner year for crypto, but also for financial product innovation in the form of derivatives-based ETFs.

[00:06:18] This also should prove to be a volume and liquidity tailwind as there are already products being built that overlay options on a core position in IBIT.

[00:06:28] Let's think about the various risk management objectives one might seek and the overlay structures they employ.

[00:06:35] First, the broad category of income strategies like overriding will supply vol to the market, typically through the sale of upside calls.

[00:06:45] Given the tendency in Bitcoin for number go up, it wouldn't be surprising to see put-right strategies created for income purposes as well.

[00:06:54] As IBIT has already listed weekly options and implied vols are in the 60s,

[00:07:00] one could envision an aggressive income-seeking strategy that sells weekly puts.

[00:07:05] Sounds dicey, but remember, I don't make the rules, I just work in a podcast.

[00:07:11] More fully hedged strategies may use collars that buy put or put spread and sell call.

[00:07:16] As we have seen, these types of systematic rules-based vehicles can become extremely large sponsors of the options markets.

[00:07:24] See JEPI, Giant Collars, and S&P 500 options.

[00:07:29] There are so many permutations that consist of a risk management overlay using puts and or calls that may seek to reduce risk,

[00:07:38] amplify returns, generate income, or some combination thereof.

[00:07:43] What makes an option contract successful is two-way interest.

[00:07:47] You need buyers and sellers, hedgers, speculators, vol traders.

[00:07:51] I can see all of this quickly materializing in IBIT options.

[00:07:56] Let's get to see why this is.

[00:07:58] Obviously, you must start with an underlying asset that is liquid and actively traded.

[00:08:04] In its short time since launch, IBIT already has a shade under $60 billion in assets under management.

[00:08:12] Some perspective.

[00:08:13] That's already more than the TLT, a government bond ETF that has been around since 2002.

[00:08:19] But there are plenty of liquid underlyings that do not spawn liquid options markets.

[00:08:25] Why the success and promise in IBIT?

[00:08:29] It's the unique risk characteristics of Bitcoin and how they shape the option vol surface in the derivatives markets.

[00:08:36] Specifically, Bitcoin has three financial characteristics that pave the way for tremendous option adoption.

[00:08:43] First, it is a high vol asset.

[00:08:46] As alluded to earlier, there are few assets with a market cap of $2 trillion moving on a $60 vol.

[00:08:53] Colgate-Palmolive is moving on a $15 vol and seeing about $5,000 of daily volume in options.

[00:09:00] Traders like vol.

[00:09:03] Second, Bitcoin exhibits a great deal of vol-a-vol.

[00:09:07] Hey now, the vol is high to be sure.

[00:09:10] The vol is also volatile.

[00:09:12] Bitcoin goes through sleepy periods and also those when the daily fluctuations are huge.

[00:09:19] And third of the financial characteristics, perhaps the most important of them, is Bitcoin's nearly unmatched propensity for positive spot vol correlation.

[00:09:30] The coin is subject to frequent upshocks, my term for substantial one-day positive returns.

[00:09:37] To be sure, it has its share of large negative returns as well.

[00:09:40] But what distinguishes it significantly from an asset like the S&P is that Bitcoin can become more volatile as it rises.

[00:09:49] The S&P doesn't really do that.

[00:09:51] If the S&P rallies by 20% over a period of time, it's a strong empirical likelihood that both realized and implied vol wind up lower than where they started.

[00:10:02] Not 100%, but a very strong likelihood.

[00:10:06] This is not the case with Bitcoin, and this has really important implications.

[00:10:10] As an aside, Bitcoin has experienced 216 5% up days and only 193 5% down days since 2017.

[00:10:22] These three factors, the vol, the vol-a-vol, and the tendency for positive spot vol correlation, lead to a regular repricing of options that make vol traders interested in trading them.

[00:10:34] Since Ibit options have only been around for a month, let's use BITO, the Bitcoin futures ETF, to make the point on vol-a-vol.

[00:10:44] Two-month implied vol on BITO has gotten as high as 105 and as low as 35 since its launch three years ago.

[00:10:52] In comparison, NVIDIA, one of the most successful single stock options ever, has had a high of 75 and a low of 33 over the same time period.

[00:11:05] Swings in implied vol add a dimension to pricing risk that attracts attention.

[00:11:10] The implied vol becomes an asset that can be range traded.

[00:11:14] The empirical distribution of Bitcoin returns matters a great deal as well.

[00:11:19] Bitcoin has proven to gap up many times.

[00:11:23] Is there an asset in the world that inspires the imagination more than Bitcoin?

[00:11:28] Is there one that creates the fear of missing out anymore?

[00:11:32] As mentioned, very low delta calls are already being priced and traded in Ibit.

[00:11:37] As I've shown a few times on Twitter, the call skew tilts up, reflecting the demand for far upside exposure.

[00:11:46] This is to say that out-of-the-money calls carry a higher implied vol than those closer to the money,

[00:11:51] something you almost never see in the S&P.

[00:11:54] Assets that exhibit upward sloping call skew also often experience stock-up vol-up.

[00:12:01] That is, unlike a broad equity index like the S&P, Bitcoin can rally and bring its implied vol up along with it.

[00:12:10] Let me repeat that.

[00:12:11] Bitcoin can rally and bring its implied vol up along with it.

[00:12:16] Let's consider this statement from both the call option buyers and option sellers standpoint.

[00:12:23] If I buy an out-of-the-money call option, I'm clearly rooting for the underlying asset to rise.

[00:12:28] I need it to reach a certain destination by a certain time in order for the trade to work.

[00:12:34] My mark-to-market profit is going to consider how far up the asset went and how long it took to get there.

[00:12:40] And my option will also incorporate any change in implied volatility.

[00:12:45] If the implied vol is rising as the asset is rising, this can add meaningful additional value to my position.

[00:12:52] To distinguish this again from the S&P, when one buys an out-of-the-money call,

[00:12:57] it's often the case that you can be right in the direction but experience some drag from volatility along the way.

[00:13:05] From the hedger standpoint, being short upside calls on IBIT can be complicated for the same reason the other side of the trade benefits.

[00:13:14] The option seller needs to manage the delta risk accordingly

[00:13:18] and appreciate the way in which a rising implied vol level can also add additional delta to the call option

[00:13:25] beyond that which results simply from the rising level of the underlying.

[00:13:30] In equity land, we don't see this often.

[00:13:33] But for certain single stocks, we can put NVIDIA and Tesla in there as examples.

[00:13:38] Stock up, vol up has sometimes been a thing.

[00:13:41] And when you see that positive reinforcement of price and vol,

[00:13:45] there's nearly always very heady action in options markets during those timeframes.

[00:13:51] The 2021 meme stock episode with GME was the ultimate example.

[00:13:56] And of course, that period was associated with an absolute surge in option volume.

[00:14:02] Let's think about how Bitcoin's tendency for up crashes

[00:14:06] and the realized and implied volatility statistics that emerge.

[00:14:10] Traditional assets like the S&P tend to take the escalator up and elevator down, as they say.

[00:14:16] The force with which markets can move lower exceeds that with which it can move up.

[00:14:22] In Bitcoin, not only are the price shocks well distributed across both the upside and downside,

[00:14:27] but so too are the volatilities.

[00:14:30] Going back to 2019, let's examine rolling one-month periods

[00:14:34] and isolate the top 25 to both the upside and downside in Bitcoin.

[00:14:39] Some of these may be overlapping, but by doing it this way, we get to see more data.

[00:14:45] For the downside sample set, the average loss is 38% among these 25 episodes.

[00:14:52] The average increase in implied vol using the BitVol series is 44,

[00:14:57] and the average increase in realized vol is 59.

[00:15:01] These aren't too surprising considering the magnitude of the losses in just a month's time.

[00:15:06] What is more interesting is the upsample.

[00:15:09] Here, of the 25 moves, the average increase in Bitcoin is 66%.

[00:15:13] That alone is remarkable.

[00:15:16] The average increase in implied vol is 27 points,

[00:15:20] and the average increase in realized vol is 14.

[00:15:23] That is a very distinguishing characteristic.

[00:15:27] Sharp rallies in the underlying are met not just with an increase in realized vol,

[00:15:31] but with an even larger increase in implied vol.

[00:15:36] This empirical observation gets to the heart of what makes Bitcoin a unique asset.

[00:15:41] The view that upside can be unbounded.

[00:15:44] It's not tethered to some valuation framework.

[00:15:47] It doesn't need to meet or beat a whisper number on the quarterly earnings report.

[00:15:52] Its price action gets our attention,

[00:15:54] and via folks like Michael Saylor,

[00:15:56] Bitcoin's unpaid head of investor relations,

[00:15:59] captures our imagination.

[00:16:01] Now, these stats are backward-looking, to be sure.

[00:16:05] It was easier for Bitcoin to surge from $8,000 to $12,000 in a few weeks in June of 2019

[00:16:11] than it will be to shoot to $150K now, or at least I think so.

[00:16:16] But the underlying characteristic of Bitcoin,

[00:16:19] to gain momentum on the way up,

[00:16:22] be subject to incredible FOMO,

[00:16:24] and to experience a positive price vol spiral remains.

[00:16:28] Because of this last point,

[00:16:31] the call skew, especially for out-of-the-money options,

[00:16:34] is going to be very well bid.

[00:16:36] And to restate,

[00:16:38] when you have price discovery at very low delta points,

[00:16:41] the entire vol surface is fortified,

[00:16:44] paving the way for all kinds of trade construction.

[00:16:48] Let's finish this podcast with some discussion of what I see in the landscape of current pricing on IBIT options.

[00:16:56] The quick skinny.

[00:16:57] Implied vol is high,

[00:16:59] the call skew is bid,

[00:17:00] and,

[00:17:01] curiously,

[00:17:02] the term structure is upward sloping.

[00:17:04] I say curiously because it's generally the case that when implied vol is high,

[00:17:09] the term structure is flat to downward sloping.

[00:17:12] Here's an example.

[00:17:13] The recent breathtaking rally in Tesla has lifted both realized and implied vol.

[00:17:18] The result is an inverted term structure.

[00:17:21] Two-month implied vol in Tesla is at 77,

[00:17:25] six-month at 68,

[00:17:26] one-year at 64,

[00:17:28] and two-year at 61.

[00:17:30] That makes sense.

[00:17:31] The market is essentially paying respect to the value in owning short-dated options in a stock that is realizing 83 over the last two months.

[00:17:40] But that's a difficult level of realized vol to sustain.

[00:17:44] And so,

[00:17:46] further out options incorporate the view that realized vol will mean revert lower.

[00:17:51] In IBIT,

[00:17:52] we see a pretty upward sloping term structure.

[00:17:56] Two-month vol is at 62,

[00:17:57] but one-year is at 70.

[00:17:59] Two-year is slightly higher than that.

[00:18:02] It's unclear how much you could actually trade out one or two years,

[00:18:06] but that is at least the starting point.

[00:18:09] Is 70 vol too high for one-year and two-year vol?

[00:18:13] Should two-year be 10 vols over two months?

[00:18:16] Listeners to this podcast will remember my analysis of vol going into the U.S. election.

[00:18:21] I explain the vol premium for options that expired just after November 5th as mostly a function of the withdrawal of supply of optionality ahead of an event that few felt comfortable handicapping.

[00:18:34] Less supply raises the clearing price.

[00:18:37] I think longer-dated vol on IBIT fits this category.

[00:18:41] There's not a lot of natural sellers ready to bear vega risk,

[00:18:44] perhaps especially given the high vol of vol I've discussed earlier.

[00:18:49] That said,

[00:18:50] I did some back tests on systematic vol selling strategies in Bitcoin,

[00:18:55] again using the BitVol series.

[00:18:57] This series, built by Simon Ho of T3,

[00:19:00] uses the SIBO-VIX methodology

[00:19:02] and is designed to approximate where a variant swap would trade on Bitcoin.

[00:19:07] If we go back to 2019 and systematically sell one-month variants,

[00:19:12] the results are outstanding.

[00:19:15] This is to say that the vol risk premium in Bitcoin has been especially and consistently high.

[00:19:20] As I stare at these longer-dated vol levels,

[00:19:24] and as I hear BlackRock now suggest that Bitcoin can constitute a 2% portfolio allocation,

[00:19:30] I wonder if this asset class will mature and stabilize,

[00:19:34] ultimately leading to lower vol.

[00:19:36] The NASDAQ VIX, the VXN, was in the 60s in 2001.

[00:19:41] Four years later, it was at 15.

[00:19:44] These are interesting questions to ponder.

[00:19:47] An emergence of systematic VRP capture strategies in IBIT

[00:19:51] would be another addition to the ecosystem of supply and demand for optionality.

[00:19:56] The last point I want to make is around that term,

[00:20:00] HODL.

[00:20:01] Mike Tyson told us everyone has a plan

[00:20:04] till they get punched in the face.

[00:20:06] I say everyone's a HODLer until faced with a positive return outcome

[00:20:10] they couldn't possibly have conceived of.

[00:20:13] If the price-vol spiral that underpins so much of what makes Bitcoin interesting

[00:20:18] actually kicks in,

[00:20:20] even Michael Saylor is going to contemplate buying puts.

[00:20:23] This way, he can still HODL,

[00:20:26] but IBIT options will allow him to HODL as well.

[00:20:30] That is, hedge up a digital loan.

[00:20:33] Well, that's about all I've got for now.

[00:20:36] If it's not been abundantly clear,

[00:20:38] I am very excited about the IBIT options launch.

[00:20:42] I'm also very excited about 2025

[00:20:44] and connecting with new guests

[00:20:46] and bringing those insights your way.

[00:20:48] In the meantime,

[00:20:49] I wish you a truly wonderful holiday season.

[00:20:52] Take some time to reflect on the good things,

[00:20:55] health, family, and friends.

[00:20:57] Be well.

[00:20:58] You've been listening to the Alpha Exchange.

[00:21:00] If you've enjoyed the show,

[00:21:02] please do tell a friend.

[00:21:03] And before we leave,

[00:21:05] I wanted to invite you to drop us some feedback.

[00:21:07] As we aim to utilize these conversations

[00:21:09] to contribute to the investment community's understanding of risk,

[00:21:13] your input is valuable

[00:21:14] and provides direction on where we should focus.

[00:21:17] Please email us at feedback

[00:21:19] at alphaexchangepodcast.com.

[00:21:21] Thanks again,

[00:21:22] and catch you next time.

[00:21:23] Thank you.