Bitcoin volatility likely because $4 billion worth of options expire on Friday
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Bitcoin (BTC) could see wild price swings heading into the weekend as billions of dollars worth of options contracts tied to the cryptocurrency expire on Friday.
At press time, the quarterly expiration on dominant crypto options exchange Deribit included 81,052 call options worth $2.24 billion and 60,261 put options worth $1.73 billion, according to data from Amberdata. Deribit, which accounts for nearly 80% of global crypto options activity, will settle its quarterly options at 08:00 UTC on Friday. On Deribit, one option contract represents 1 BTC.
“There are massive quarterly options expiring tomorrow,” said Dick Lo, managing director and co-founder of TDX Strategies. “The Street is potentially short gamma on the upside. That plus thin liquidity could lead to big notches in either direction.”
Options are derivative contracts that give the buyer the right, but not the obligation, to buy or sell the underlying asset at a predetermined price on or before a specific date. Call options give the right to buy; gives the right to sell. Investors use options to hedge their positions in the spot or futures market against adverse price movements and speculate on future trends in valuations and volatility.
On the other side of the transaction are dealers or market makers, who provide liquidity to an order book by creating buy and sell orders. Market makers profit from the spread between bid and ask prices and trade the underlying asset to keep their net exposure market neutral. Their hedging activity often creates volatility, especially ahead of major expirations, such as the one due on Friday.
Bitcoin has risen 23% this month, largely due to the US banking crisis and the resulting reduction in the Federal Reserve’s interest rate expectations. The rally spurred demand for call options at higher strike prices, leaving market makers with a large negative or “short gamma” position on the upside. Being short gamma on the upside means having a short position in call options, which give holders protection against price appreciation.
If bitcoin were to extend its gains before the weekend, market makers would be forced to hedge their short gamma exposure by buying the cryptocurrency in the spot or futures market. This in turn can lead to more volatility on the upside.
“Because of bitcoin’s price rally caused by the banking crisis in mid-March, a large amount of negative gamma was in the hands of market makers,” said Griffin Ardern, a volatility trader at crypto-asset management firm Blofin. “There is a lot of negative gamma at strikes $28,000 and $29,000, which means that the upward price movement will push market participants to buy.
“When gamma is at its most negative and price rises/falls by 1%, market makers need to buy/sell $50 million worth of BTC spots or futures to hedge their exposure,” Ardern said.
Bitcoin surged past $29,000 early Thursday, only to quickly fall back to $28,300 in a two-way move reminiscent of the volatile bull market days of early 2021. The gamma squeeze by market makers likely caused the pop and fall, according to Ardern.
The effect of market participants’ hedging may be more pronounced than ever, thanks to deteriorating liquidity conditions. Liquidity, measured at 2% market depth, fell to a 10-month low early this month, making it difficult for traders to execute large deals without causing large price movements.
At press time, bitcoin was changing hands near $28,650, a gain of 1% over the past 24 hours, CoinDesk data shows.
