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Volatility markets this week remained relatively tame apart from a spike in vol caused by the almost $2000 moves on Tuesday the 29th and Thursday the 31st. Shorter dated vols reacted more violently to the fast move up last week, however they quickly tapered back down to previous levels. At the Money implied vols currently sit virtually at the same level as a week ago with closer dated vols at 33 - 37 and longer dated vols starting at 40 and topping out at 48 for June 2024 expiry.
Although the general levels of the volatility surface did not change much, the skews of the implied volatility smiles noticeably changed after this week's price action. As can be seen from the graphs below, put side skew is prevalent in all tenures but most prevalent in shorter darted smiles. The evolution of skew over subsequently larger tenures is known as the “Term Structure of Skew” and it is currently increasing. This is because shorter dated tenures have higher skew to the put side (more negative skew) than longer dated tenures (skew closer to 0). Normally ETH vol smiles consistently exhibit this property but BTC now also exhibits negative skew, as more downside seems to be priced in.
Skew refers to the relative pricing of calls and puts of equal delta around ATM (At the Money). Recall that an alternate measure of distance from ATM is delta. For example lower delta calls / puts will be further out of the money (higher strike for calls, lower strike for puts). Thus traders will usually refer to calls and puts by their deltas rather than by their strikes. To measure which side (calls or puts) the market is pricing higher, we can look at the relative tilt of the volatility smiles. If the smile is higher on the call side, all else held equal, calls are being priced at higher implied vols. The simplest measurement of skew is given by subtracting the implied vol of the put from the implied vol of the call. For example, the 25Delta skew = 25Delta Call_IV - 25Delta Put_IV. From this calculation we can see that if skew is positive, call iv must be higher and vice versa.
Intimately related to this measure is the Risk Reversal position. The Risk Reversal is a long OTM call and a short OTM put. This is a bullish position since both of its components, the long call and the short put, benefit from an increase in price. The higher the skew, the more this position will cost since the premium paid for the call will be more than the premium received by selling the put. This agrees with intuition since a bullish market will show higher skew in options’ prices, and thus one will have to pay more to take bullish exposure with options. The price of the Risk Reversal is thus the most direct link to skew, and since normally equal delta calls and puts are used, the difference between their implied volatilities is what makes the most material difference in net premium.
Digging deeper into BTC Deribit and Paradigm block trade data we see the biggest volumes in Call Diagonal Spreads, Strangles / Straddles, and Call Spreads (33.8%, 18.1%, 14%). Ethereum volume data shows a similar mix of skew based vertical spreads. The top 3 traded spreads were Call Spreads, Put Spreads, and Risk Reversals (21.7%, 21.7%, and 17.7%). Most Call Spread and Put Spread activity for both coins was long, with concentrations in September and some activity in December.
BTC Combo Spread Volumes:
ETH Combo Spread Volumes:
***Data and insights as of August 28th, 2023 15:00:00 UTC
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