Trading Strategy: Hedge your profits and play the skew
Over the last 2 weeks, we crossed consecutively, with hardly any real pull back, the 14,000, the 15,000, the 16,000, the 17,000 and the 18,000 level. The speed of that rally has taken even the most enthusiastic BTC hodlers aback.
The flow of bullish news has been uninterrupted, being company putting reserves into crypto, payment services expanding into digital assets or billionaires just wanting to ride that train, just in case it transforms itself into a rocket and makes it to the Moon.
Yesterday, by flirting with the 18,500 level we made new all time high for the Bitcoin market Capitalisation. At $340bn, we broke the previous record dating from December 2017 when BTC traded briefly above 20,000.
With long term investors taking their coins off exchange to place them in custody, ETP crypto and long only funds like Greyscale growing exponentially, the free float has been greatly reduced and a wave of new investors has provoked a big supply-demand imbalance. With miners getting 900 BTC a day (a bit more than 1000 if we include gas fees), it’s not the kind of supply that can absorb institutional money.
If we look at the derivatives market, we see a perfect reflection of this environment. Restrained liquidity has created high volatility. Implied volatility has been going up over the last 2 weeks, with 1 month vol going up by 10 points and 1 week vol going up by 20. But more than that skew has been dropping massively due to the demand for upside.
For long BTC holders, we think this could be an opportunity to lock in some of their upside gains by hedging their downside risk and taking advantage of the negative skew.
The 20k level is gonna be a very important psychological barrier and we think that the number of people willing to enter the market above that level, considering what happened after 2017 highs, is reduced in the short term.
Looking at the 25dec2020 expiry we can buy the 16k put vs selling the 24k call. It would cost less than $300 to put on and considering that 16k is only 2000 points away from here while 24k is 6000 points away, it offers a good cost/protection balance. In that scenario, we would be buying 71% vol and selling 87% vol. The vega exposure of this strategy is small long here, will become longer on the downside and short on the upside. At expiry, it will make money if market expires below 15700. But having a current delta of -45%, it will offer immediate protection for any down move from here.
Alternatively, to minimise cost the 15K/24K risk reversal can be put on for a slight positive credit and present a -36% delta.
As stated above, we would suggest this strategy to investors being already long BTC and willing to hedge some of their exposure.
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