options

Watch For Lightning

The fat pitch is near. Don't miss it.

Ben Lilly, JJ

Jun 21, 2024 — 6 min read

The clouds began to darken while the cool breeze came rolling through.

I knew it was only a matter of time before the skies opened up, cleansing the hot ground below with buckets of rain.

This was mother nature’s signal that it was time for me to take cover under my porch and watch the rain play out.

There are few things I enjoy more than a summer storm.

Especially the kind that creeps in unexpectedly late in the afternoon after a hot long day in the sun…

It’s a refreshing change that reminds me to slow down and calm my otherwise hectic overheated mind.

I’ve done it ever since I was a kid, and my favorite part has always been catching the huge crashes of lightning that often accompany the storm.

One moment the environment is calm and docile, the next a giant flash comes bolting out of the sky leaving an earth shaking echo of thunder in its wake.

It’s startling if you’re not prepared for it.

Sometimes it’s violent enough to wake you up from a deep sleep.

But if you’re actively watching the storm play out, it’s not surprising at all. There’s always a few moments of delay between when the lightning strikes and the thunder roars.

I bring this up now because it reminds me a lot of what’s been going on with crypto volatility (or lack thereof) in recent weeks.

We’re in the calm phase of the storm, with prices slowly chopping down. And we only have raindrops, no flashes of lightning before a thunderous boom.

This lack of volatility and the boredom is lulling most people to sleep.

Meanwhile those of us who are actively monitoring the storm each day know that before too long, the roaring thunder of increased volatility will arrive again and startle the market back to life.

And with the large Q2 expiry close we discussed last week only a week away now, let’s dive into some options data and see what to be on the look-out for as we attempt to catch lightning (volatility).

Summer Doldrums

What was boring has only gotten boring-er.

There’s perhaps no data point that sums up how docile Bitcoin has become better than this B-VOL chart, which is a measure of its realized volatility levels dating all the way back to 2016.

As we can see below, prior to the summer of 2022 Bitcoin was historically realizing volatility levels in the range of 30-180. Then it suddenly fell off a cliff following the collapse of Celsius and BlockFi two years ago and never returned to form.

It’s been anemic ever since.

Neither the implosion of FTX, nor this past March’s run to new all time highs could breathe it back to life as each time it rallied it fell flat short of 30 and failed to recapture the previous range.

There’s an argument to be made that this diminishing volatility is all a part of the institutional adoption curve and we’ll never see such wild price action again due to the sophistry of Blackrock and the like who currently run the market.

That has some truth to it and I doubt we’ll ever experience 2017-esque runs of prolonged volatility again.

But I also can’t help but notice the similarity between where realized volatility levels are now and where they were in July 2020 a few months after that cycle’s halving took place.

Looking at the arrows below you’ll see that between April and July of 2020 the market fell into a choppy period of consolidation below the crucial psychological resistance level at $10,000.

This consolidation period caused BVOL to bottom near the 2018-2019 bear market lows, before the $10k breakout in late July which sent realized volatility levels on a parabolic run of over 7x run by January of the following year.

When we compare that to current B-VOL readings, we can see the similarities as we once again experienced a top in realized volatility in March. And now as we near July, we are a wick away from December 2022, retesting the bear market bottom.

Now does this mean we’ll return to 100+ levels of realized volatility as we did in 2020-2021?

Likely not, but a parabolic ascent to 50+ levels later this year certainly seems possible.

That sort of move would translate to an increase of 300%+ in realized volatility levels by the end of the year.

If you thought those overheated options premiums we pointed out back in March were juicy yield trades, just imagine what IV levels would look like if realized volatility were to spike again…talk about catching lightning.

Which brings me to my next point, the reflexivity of volatility.

Implied Opportunity

Low realized volatility begets low implied volatility.

Conversely, high volatility begets high implied volatility.

This is an odd phenomenon in options markets where prices along the IV curve are more a measure of where Bitcoin has been in the recent past, rather than where it’s likely to go in the future.

Here we can see implied volatility levels as measured by BVIV track very closely with the realized volatility levels reflected by B-VOL in orange.

This means that if BTC realized volatility levels were to fall back towards the bear market lows in the coming weeks, implied volatility levels would follow with them.

It’s possible we see capitulation and a return to the January lows on BVIV at 40 or below in the coming weeks.

Now if you would’ve told me back in March that we’d get another chance to long volatility at such low a level I likely wouldn’t have believed you, but that outcome is looking more and more likely with each passing day of chop.

This circles back to what we mentioned last week and back in late May in regards to ETH: let the perfect set-up come to you rather than rushing into positions during times of uncertainty.

If such a realized and implied drop were to happen it would make contract pricing all the more attractive for Q3 and Q4 expiries and dramatically increase the risk-reward ratio of such positioning.

It may sound insane, as the chart below shows September’s expiry is already trading below 55% and December’s below 70% - a 10%+ drop off for both as compared to where they were a month ago, but if B-VOL makes a final fall in July these will almost certainly follow it down.