AD Derivatives Newsletter: Fed Rate Cut, BTC Vol & Institutional Flows

USA Week Ahead (ET):

Every day of the Week - Various Fed speakers

1. Monday 9:45a - PMI

2. Tuesday 9:00a - S&P Case-Shiller home price index

3. Wednesday 10a - New home sales

4. Thursday 8:30a - GDP

5. Friday 8:30a - PCE

Disclaimer: Nothing here is trading advice or solicitation. This is for educational purposes only.

Authors have holdings in BTC, ETH, and Lyra and may change their holdings anytime.

MACRO

The big story last week was the massive rate cut of -50 basis points by the Fed. Only one Fed governor, Michelle Bowman, dissented, advocating for a smaller cut of -25 basis points.

Here are a few important considerations regarding this move by the Fed:

First, historically, Fed easing cycles often precede a recession. Currently, the unemployment rate is at 4.2%, up from 3.7% in January. Relatively speaking, the employment landscape remains robust and is likely near the natural level of "full employment."

Chart: WSJ.com

This easing cycle is a nice tailwind for hard assets such as Gold, Silver and Bitcoin. Ethereum is more of a mixture of tech and hard money. 

Chart: Finviz 

We can see the monthly Gold trend remains strong into new all-time highs. 

Chart: WSJ.com

Another dovish aspect of the Wednesday FOMC rate decision was the future projection of rate cuts. The Fed sees continued rate cuts throughout 2025, bringing rates down to 3.5%. 

The Fed also expects the longterm neutral rate to be around 3.5%, saying that we’re unlikely to drop back to ZIRP (zero-interest-rate-policy). 

Chart: WSJ.com

This week, Fed governors are speaking every day, likely defending and reinforcing their dovish stance. Michelle Bowman, the potential hawkish outlier, will speak at 9 a.m. ET on Tuesday.

On Friday, the PCE Index will be released at 8:30 a.m. This is the Fed’s preferred inflation gauge and will likely influence their decisions for the November and December policy meetings, where rate cuts are expected.

Chart: NOVEMBER 7th CME FedWatch Tool

Chart: DECEMBER 18th CME FedWatch Tool

BTC: $62,815 (+5.3% / 7-day)

ETH :$2,570 (+8.1% / 7-day)

SOL :$147.28 (+8.2% / 7-day)

Crypto Options Overview

The biggest and most exciting news released last week was the approval of options on the BlackRock spot Bitcoin ETF IBIT. 

There are two camps regarding the potential impact of IBIT options.

One camp believes these options will increase volatility, while the other believes they will decrease volatility.

Looking through our wealth of data on Bitcoin options and volatility, we can break down the perspectives into two distinct scenarios: cyclical (short-term) and structural (long-term trends).

In my view, 2020 serves as the best template for a cycle of both spot price increases and volatility spikes!

Chart: BTC Spot Performance

The above chart compares Bitcoin’s annual performance in 2020 to 2024.

If we see a Trump presidency, further interest rate cuts, and significant inflows and adoption into spot ETFs, a massive Q4 rally into the end of 2024 could happen.

What would that mean for volatility?!

Chart: ATM implied Volatility

First, take note of the implied volatility (IV) profile for 30, 90, and 180 days to expiration (DTE).

In Q4 2020, IV reached as high as 150%, while today it’s around 50%. A strong rally in Q4 could easily push IV back to the median of about 80%.

Chart: BTC realized Volatility 1/1/2020 to Present

Looking at the distribution of realized volatility from January 2020 to today, we see that the current 90-day RV is around 57%, below the median of 62%.

A bullish breakout past all-time highs, towards the $100k price zone, could easily push realized volatility back towards the upper 75th percentile, around 74%.

Chart: ∆25C - 25P / ATM IV

What about the symmetry of the volatility smile in this scenario?

Using Q4 2020 as a template, the 25∆ Risk Reversal traded as high as +20% of ATM volatility to the call side versus puts. This means upside calls would experience a massive surge in value, as OTM call deltas increase due to Vega effects while, at the same time, spot prices rise toward OTM call strikes.

However… a big however...

If this scenario plays out, it would likely be the "last hurrah" of such magnitude for Bitcoin volatility and volatility of volatility.

Ultimately, flows drive everything. Institutional flows, in particular, are counter-cyclical. Portfolio managers tend to trim exposure through quarterly rebalancing, selling appreciating assets when Bitcoin rallies too much.

Another well-known effect of these flows is their impact on implied volatility. Institutions buy protective puts and sell covered calls, which dampens upside implied volatility.

Chart: Bitcoin Realized Volatility 

The Volatility Paradox:

Bitcoin's market cap needs institutional inflows for its value to increase. However, as institutional ownership grows, their behavior has a greater impact. This means that, ultimately, institutional adoption leads to lower volatility in Bitcoin.

This is merely a continuation of the clear structural decline in Bitcoin’s volatility, as shown above.

TL;DR:

Volatility could spike as institutional inflows initially occur, as a result of the perfect bullish storm for Bitcoin in Q4 2024. However, in the long term, volatility is expected to decrease.

This sets up two potential great trades!

Paradigm's Week In Review

Paradigm Top Trades This Week

Weekly BTC Cumulative Taker Flow

Weekly ETH Cumulative Taker Flow

BTC Cumulative OI

ETH Cumulative OI

BTC

ETH

The Squeethcosystem Report (9/15/24 - 9/22/24)

Crypto markets were active this week ending up, ending the week roughly flat. ETH ended the week at 9.83% and oSQTH ended the week at 17.92%.

Volatility

oSQTH IV is 116.90% vs. its ref vol. at 70.04%.

Crab Strategy

Crab saw losses this week ending -0.76%.

Twitter: https://twitter.com/opyn

Discord: discord.gg/opyn

AMBERDATA DISCLAIMER: The information provided in this research is for educational purposes only and is not investment or financial advice. Please do your own research before making any investment decisions. None of the information in this report constitutes, or should be relied on as a suggestion, offer, or other solicitation to engage in, or refrain from engaging, in any purchase, sale, or any other investment-related activity. Cryptocurrency investments are volatile and high risk in nature. Don't invest more than what you can afford to lose.