IBIT...The Hottest Option on the Planet
An Amazing Start for Listed Options on Bitcoin
Hello Alpha Exchangers! Larry David’s 3 day statute of limitations aside, I wish you a Happy New Year! I started this Substack a few years back and haven’t done much with it. In reviewing the Alpha Exchange podcast episodes from 2024, I realized, however, that I had an opportunity to share some of what I am writing in creating the self-narrated episodes of the pod. Some folks prefer to listen, some to read. Let’s provide choice, I say.
The idea will be to share some of the insights I’ve developed over my more than 3 decades in the markets business and on the sell-side. Expect an emphasis on risk. Expect a heavy dose of vol. Expect some war stories and how we can learn the most about markets by studying the periods when things go horribly wrong.
I’m going to start by sharing the text from the most recent podcast on bitcoin options: “IBIT…The Hottest Option on the Planet”. Here goes…
My personal market lens incorporates a healthy dose of reflexivity. Prices aren’t just outcomes, they are calls to action. And from this perspective, realized vol is a cause not an effect. Realized vol of 6 causes just about nothing…except inaction. 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. Similarly, market insurance may cheapen up when the SPX swings flatline…but so what, you’re in no rush to spend the money on it. I get it.
The quiet at the SPX notwithstanding, other asset classes and securities are moving around, however. I count 4 of them in the 2 Trillion valuation club that sport implied vols north of 45. That includes TSLA, Broadcom, NVDA and the subject of this forthcoming discussion, Bitcoin. Among these 4 beasts, there’s 10T of combined value, running north of 45 volatility. To state the obvious, 45 vol is easy come easy go. The former has certainly been the theme for these 4. Heck, the RICH go screen on Bloomberg has Elon at 450bln. Can Bezos even be in the same room as Musk? Not that Elon is invested in T-Bills, like Warren Buffett is, but the risk free interest on his stack would be 50mln per day. Believe it or not, TSLA is the worst performer of this Fantastic Four, up just 62% in 2024.
That short digression behind us, let’s zero in on the subject at hand… the unbelievable launch of options on IBIT, the bitcoin ETF. What I’d like to put forth is that the financial characteristics of the underlying asset – bitcoin - pave the way for IBIT options – already off to an amazing start – to become a critical industry risk management tool. Next, I want to acknowledge that while the crypto crew likes to HODL, listed options on IBIT will allow them to HUDL as well… that is, hedge up digital longs. C’mon you folks know I’m an acronym-phile. You may never want to sell, that’s fine. 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.
Let’s talk about IBIT listed option activity so far. One month in and the volumes are absolutely fantastic. On December 16th, nearly 500,000 puts and calls traded. Citibank – a bank around for a hundred years and with a stock price in the same neighborhood, saw volumes less than 20% of that. The IBIT volumes are leading to substantial levels of open interest, which has reached just under 2mln contracts. Why is this important? When investors have trades "on the books", they become arbiters of the "right price", invested in understanding where a structure might trade. Two counterparties that opened a trade together are well positioned to roll it together as well. Of course, the front months are the most populated, but even out to May'25, there are thousands of contracts of open interest.
Transactions are occurring across the strike curve, not just in ATM or near the money options. In Jan'25, there are nearly 35k calls of open interest with strikes above 75. these options have deltas between 3 and 12 and are roughly 5 cents wide at vols of 80+. having price discovery at these low delta points bolsters the capacity to price spreads and tail hedges. 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, a counterparty asked to make a price on the 70 strike call will do so with more confidence as the 80’s can be bought as part of the hedge if needed.
Let’s next talk about posted bid-offer spreads. These will surely tighten over time, but screen-based price discovery is already solid. that is, posted interest is often in the 1000's of contracts on both sides of the market and often a dime wide. These are simply what’s posted and trades will mostly occur inside that. Again, there’s an ecosystem of liquidity being built here as more open interest accumulates. The pricing bots at Jane and Susq and Citadel get smarter and smarter along the way, observing where things trade, repricing second by second and building intelligence on the relative levels of premium that populate the matrix we Geeks call the vol surface. There’s a virtuous cycle afoot.
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. 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. Let’s think about the various risk management objectives one might seek and the overlay structures they employ. First, the broad category of "income" strategies like overwriting will supply vol to the market, typically through the sale of upside calls. Given the tendency in bitcoin for “number go up”, it wouldn’t be surprising to see put write strategies created for income purposes as well. As IBIT has already listed weekly options and implied vols are in the 60’s, one could envision an aggressive income seeking strategy that sells weekly puts. Sounds dicey, but remember, I don’t make the rules, I just work at a podcast.
More fully hedged strategies may use collars that buy put or put spread and sell call. As we have seen, these types of systematic, rules-based vehicles can become extremely large sponsors of the options markets. see JEPI, giant collars and SPX options. There are so many other permutations that consist of a risk management overlay using puts and or calls that may seek to reduce risk, amplify returns, generate income or some combination thereof.
What makes an option contract successful is two-way interest. You need buyers and sellers, hedgers, speculators, vol traders. I can see all of this quickly materializing in IBIT options. Let’s get to why that is. Obviously, you must start with an underlying asset that is liquid and actively traded. In its short time since launch, IBIT already has a shade under 60bln in AuM. Some perspective: that’s already more than the TLT, a government bond ETF that has been around since 2002.
But there are plenty of liquid underlyings that do not spawn liquid option markets. Why the success and promise in IBIT? It is the unique risk characteristics of bitcoin and how they shape the option vol surface in IBIT. Specifically, bitcoin has 3 financial characteristics that pave the way for tremendous option adoption: First, it is a high vol asset. As alluded to earlier, there are few assets with a market cap of 2 trillion moving on a 60 vol. Colgate Palmolive is moving on a 15 vol and seeing about 5k of daily volume in options. Traders like vol. Second, bitcoin exhibits a great deal of vol of vol. Hey now. The vol is high to be sure. The vol is also volatile. Bitcoin goes through sleepy periods and also those when the daily fluctuations are huge.
And the third of the financial characteristics – perhaps the most important of them – is bitcoin’s nearly unmatched propensity for positive spot/vol correlation. The coin is subject to frequent "up shocks", my term for substantial one-day positive returns. To be sure, it has its share of large negative returns as well, but what distinguishes it significantly from an asset like the SPX is that bitcoin can become more volatile as it rises. The SPX doesn’t really do that. If the SPX 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. Not 100%, but a very strong likelihood. This is not the case with bitcoin, and this has really important implications. As an aside, Bitcoin has experienced 216 5% up days and only 193 5% down days since 2017.
These 3 factors – the vol, the vol of vol, and the tendency for positive spot/vol correlation - lead to a regular repricing of options that make vol traders interested in trading them. Since IBIT options have only been around for a month, let's use BITO to make the point on vol of vol. 2m implied vol on BITO has gotten as high as 105 and as low as 35 since launch 3 years ago. In comparison, NVDA, one of the most successful single stock options ever, has had a high of 75 and a low of 33 over the same period. Swings in implied vol add a dimension to pricing risk that attracts attention. The implied vol becomes an asset that can be range traded.
The empirical distribution of bitcoin returns matters a great deal as well. bitcoin has proven to "gap up" many times. Is there an asset in the world that inspires the imagination more than bitcoin? Is there one that creates the fear of missing out more? as mentioned, very low delta calls are already being priced and traded. as I have shown a few times on Twitter, the call skew tilts up, reflecting the demand for far upside exposure. This is to say that out of the money calls carry a higher implied volatility than those closer to the money, something you almost never see in the SPX. Assets that exhibit upward sloping call skew also often experience "stock up, vol up"...that is, unlike a broad equity index like the SPX, bitcoin can rally and bring its implied vol up along with it.
Let me repeat that. Bitcoin can rally and bring its implied vol up along with it. Let’s consider this statement from both the call option buyer’s and option seller’s standpoint. If I buy an out of the money option, I’m clearly rooting for the underlying asset to rise. I need it to reach a certain destination by a certain time in order for the trade to work. My mark to market profit is going to consider how far up the asset went and how long it took. And my option will also incorporate any change in implied volatility. If the vol is rising as the asset is rising, this can add meaningful addition value to my position. To distinguish again, from the SPX, when one buy an OTM call, it’s often the case that you can be right on the direction, but experience some drag from volatility along the way.
From the hedger’s standpoint, being short upside calls on IBIT can be complicated, for the same reason the other side of the trade benefits. The option seller needs to manage the delta risk accordingly and appreciate the way in which a rising level of implied vol can add additional delta to the call option beyond that which results simply from the rising level of IBIT.
In equity land, we don’t see this often. But for certain single stocks – we can put NVDA and TSLA in there as examples, “stock up/vol up” has sometimes been a thing. And when you see that positive reinforcement of price and vol, there’s nearly always very heady activity in the options market. The 2021 Meme stock episode with GME was the ultimate example, and, of course, that period was associated with an absolute surge in option volume.
Let’s think about how bitcoin’s tendency for up-crashes and the realized and implied volatility statistics that emerge. Traditional assets like the SPX tend to take the escalator up and elevator down, as they say. The force with which the market can move lower exceeds that with which it can move up. In bitcoin, not only are the price shocks well distributed across both the upside and downside, but so too are the volatilities. Going back to 2019, let’s examine rolling one month periods and isolate the top 25 to both the upside and downside. Some of these may be overlapping, but we get more data doing it this way. For the downside sample set, the average loss is 38%. The average increase in implied vol, using the BITVOL series, is 44 and the average increase in realized vol is 59. These aren’t too surprising considering the magnitude of the losses in just a month’s time.
What is more interesting is the up sample. Here, of the 25 moves, the average increase in bitcoin is 66%. That alone is remarkable. The average increase in implied vol is 27 points. And the average increase in realized vol is 14. That’s a very distinguishing characteristic. Sharp rallies in the underlying met not just with an increase in realized vol, but an even larger increase in implied vol. This empirical observation gets to the heart of what makes bitcoin a unique asset, the view that the upside can be unbounded. It’s not tethered to some valuation framework. It doesn’t need to meet of beat a whisper number on the quarterly earnings report. It’s price action gets our attention and via, folks like Michael Saylor, Bitcoin’s unpaid head of investor relations, captures our imagination.
Now, these stats are backward looking, to be sure. It was easier for bitcoin to surge from 8k to 12k in a few weeks in June of 2019 then it will be to shoot to 150k now. Or at least I think so. But, the underlying characteristic of bitcoin – to gain momentum on the way up, be subject to incredible FOMO and to experience a positive price/vol spiral, remains. Because of this last point, the call skew – especially for very out of the money options, is going to be very well bid. And to restate, when you have price discovery at very low delta points, the entire vol surface is fortified, paving the way for all kinds of trade construction.
Let’s finish this podcast with some discussion of what I see in the landscape of current price on IBIT options. The quick skinny: implied vol is high, the call skew is bid and, curiously, the termstructure is upward sloping. I say curiously, because it’s generally the case that when implied vol is high, the termstructure is flat to downward sloping. Here’s an example. The recent breathtaking rally in TSLA has lifted both realized and implied vol. The result is an inverted termstructure. 2m vol is at 77, 6m at 68, 1y at 64 and 2y at 61. That makes sense. The market is essentially paying respect to the value in owning short dated options in a stock that is realizing 83 over the last 2 months. But, that’s a difficult level of realized to sustain. And so, further out options incorporate the view that realized will mean revert lower.
In IBIT, we see a pretty upward sloping termstructure. 2m implied vol is 62. But one year is 70. 2 year is slightly higher than that. It’s unclear how much you could actually trade out one year, but that’s at least the starting point. is this too high? should 2 year be 10 vols over 2 month? Listeners to this podcast will remember my analysis of vol going into the US election. I explained 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. Less supply raises the clearing price. I think longer dated vol on IBIT fits this category. There’s not a lot of natural sellers ready to bear the vega risk, perhaps especially given the high vol of vol I’ve discussed earlier.
That said, I did some back-tests on systematic vol selling strategies in bitcoin, again using the BITVOL series. This series, built by Simon Ho of T3, uses the CBOE VIX methodology and is designed to approximate where a variance swap would trade on bitcoin. If we go back to 2019 and systematically sell 1m variance, the results are outstanding. This is to say that the Vol Risk Premium in bitcoin has been consistent and high. As I stare at these longer dated vol levels especially and as I hear BlackRock now suggesting that bitcoin can constitute a 2% portfolio allocation, I wonder if this asset class will mature and stabilize, leading to lower vol? The Nasdaq VIX, the VXN, was in the 60’s in 2001. 4 years later it was at 15. These are interesting questions to ponder. An emergence of systematic VRP strategies in IBIT would be another addition to the ecosystem of supply and demand for optionality.
The last point I want to make is around that term, HODL. Mike Tyson told us, everyone has a plan till they get punched in the face. I say, everyone’s a HODLer until faced with a positive return outcome they couldn’t possibly have imagined. If the price/vol spiral that underpins so much of what makes bitcoin interesting actually kicks in, even Michael Saylor is going to contemplate buying puts. This way, he can still HODL. But IBIT options will allow him to HUDL as well.
Well, that’s about all I’ve got for now. If it’s not been abundantly clear, I am very excited about the IBIT option launch. I’m also very excited about 2025 and connecting with new guests and bringing those insights your way. And I do love Larry David, but I will say it again, Happy New Year!