Bitcoin Puts: The Bargain of the Century

Bitcoin and other cryptocurrencies are becoming an increasingly important contributor to investors’ portfolios. This is not only because of the returns that can be gained on the underlying assets, which can be large and uncorrelated to other asset classes. But at the derivative level, they are also increasingly recognized as being an important contributor to portfolio performance.

Take BTC puts. These give the holder the right, but not the obligation, to sell BTC at an agreed price on or before a specified date. In other asset classes, puts are expensive, as they provide an insurance policy against falling prices. But bitcoin puts are cheap because of the peculiar psychology of crypto market participants, who fear missing the upside more than losing on the downside.

“In equities, everyone wants puts because puts are insurance and you have to pay for insurance,” says Euan Sinclair, an options trader and one of the authors of a recent report by Amberdata that looked at four years of BTC options trading data. “The cheaper in dollar terms the puts are, the more expensive they are in volatility terms. This is almost as close to a universal law of nature as we have in the volatility space. And we don't see that in crypto.”

The reason is that in crypto, the vast majority of traders are more concerned with missing the upside price movements than they are with protecting against market crashes. As a result, there is less demand for puts and more demand for calls. Puts are cheap and calls are consequently expensive.

“Anyone who has traded equity vol knows that stocks will crash quickly and rally up more slowly. This is especially true with indices, which have a diversification component embedded in there as well,” says Greg Magadini, director of derivatives at Amberdata and a co-author of the report. “What we see in Bitcoin is a FOMO [fear of missing out] environment. When the Bitcoin price is crashing or floating down, no one cares about it. But when it's rallying up, everyone is googling bitcoin and working out how to buy Bitcoin. Everyone suddenly wants to get long Bitcoin so you have these violent upside moves.”

This insight can be the foundation of not just a specific Bitcoin options trading strategy, but can also play a very exciting role within a wider investment portfolio. Portfolio returns are not just generated from capturing the right market price moves. They can be further generated by playing the correlations between the asset classes that comprise an overall portfolio.

“I think this is the most exciting thing,” says Sinclair. “Everyone has heard of buying puts in fear of a Black Swan, a rare event. Well, the real rare event is finding cheap puts. And that's what we've done here. You can make money buying them in the Bitcoin space alone, which is nice. But the real point is they can become a positive carry disaster hedge. The overall correlation between Bitcoin and equities is not high at around 30% on a daily level. But during the COVID crash, that correlation nearly doubled. It is clear that in a massive panic, Bitcoin does go down with equities. And that's when buying cheap puts is really going to kick in and help. The point is that these puts are the bargain of the century and a generational buying opportunity.”

Euan Sinclair and Greg Magadini were speaking at a webinar hosted by CoinDesk and sponsored by Amberdata to discuss the findings of a ground-breaking report that analyzed four years of Bitcoin option trading data. As well as discussing the pricing dynamics of Bitcoin calls and puts, they discussed other profitable trading strategies, including risk reversal strategies, the time the market generally spends in contango and backwardation and how the market’s term structure feeds into its volatility dynamics.