Original author: BitMEX
Welcome back to our periodic options strategy series. Today, we will share a unique trading opportunity brought about by significant differences in the Bitcoin options market.
Currently, the implied volatility (IV) of Bitcoin call options is spiking, while put options seem undervalued.
In this article, we will analyze this IV skew phenomenon and propose a strategy that could profit from an increase in put option IV. Given the current market's heavy bias towards call options, we believe this contrarian strategy could be particularly rewarding!
Let's start the analysis.
Bitcoin Implied Volatility (IV) Skew Analysis
As shown in the BitMEX options table for BTC options expiring on January 31, 2025, the IV skew between call and put options is about 25%, with call options having significantly higher IV.
This indicates strong demand for call options in the market, reflecting bullish market sentiment or a hedge against upside risk. This pronounced skew highlights the supply-demand imbalance, making put options relatively cheaper and creating potential opportunities for volatility trading strategies.
Consider a ratio put spread strategy.
If you believe that BTC put options will become more expensive and/or that the BTC price will experience a significant adjustment in the next two months, we suggest you consider a ratio put spread strategy.
This trading strategy aims to leverage multiple market dynamics:
By profiting from the potential rise of IV, particularly in out-of-the-money put options, we can take advantage of the volatility skew. Due to the skew, these options currently have lower premiums, meaning their value will increase more rapidly when volatility spikes (especially during market sell-offs).
It also provides a smart directional trade with limited downside risk, allowing traders to benefit from any significant decline in BTC below 82,000 USD. To effectively manage risk, the structure includes selling one at-the-money put option, which helps offset the costs of the two bought out-of-the-money put options, thereby reducing the net debit and limiting upfront risk.
How to implement your market view
Trading Strategy:
Sell 1 BTC 96,000 USD at-the-money put option expiring on January 31, 2025.
Buy 2 BTC 90,000 USD out-of-the-money put options expiring on January 31, 2025.
Scenario and Profit Analysis
This trade can profit in two ways. First, through an IV spike before expiration—ideally occurring early to minimize the negative impact of time value decay (the reduction in option value as expiration approaches). Second, through a significant drop in BTC price, turning our 2 out-of-the-money put options into in-the-money and generating profits.
Scenario Analysis:
IV rises: The trade benefits from an increase in put option IV, especially at out-of-the-money strike prices.
BTC plummets sharply: Significant downward price movements amplify the value of the 90,000 USD put option, while the 96,000 USD put option offsets the cost.
IV declines: The trade is adversely affected when the IV of put options declines, especially if the out-of-the-money strike prices experience greater IV compression.
BTC rallies strongly: Significant upward price movements harm the trade as they decrease the value of both put options.
Scenario 1: The IV never spikes during the trade.
If the IV has never spiked during the trade period, the only way for the strategy to profit is through a significant drop in Bitcoin.
Scenario 2: IV spikes occur.
If the mid-term IV can spike by 50% before the option's expiration, as long as BTC trading price is below 97,000 USD and we can close the position, we can achieve decent profits. You can use BitMEX's strategy simulator to simulate the different impacts of time decay and IV spikes on your profits.
Risks and Considerations
1. Maximum Loss:
If Bitcoin's trading price is 90,000 USD on the expiration date, the trade will result in maximum loss.
2. Skew Compression:
If the IV skew narrows (for example, if the IV of out-of-the-money put options decreases further relative to at-the-money IV), the trade may lose its edge.
3. Directional Risk:
A moderate decline (e.g., 92,000-93,000 USD) may lead to partial losses, as the loss from the sold at-the-money put option exceeds the gain from the bought out-of-the-money put options.
4. Time Decay:
Time decay is detrimental to bought out-of-the-money put options, requiring sufficient IV increase or price movements to overcome this drag.
Summary
This ratio put spread strategy takes advantage of the current IV skew, providing a structured way to profit from an increase in Bitcoin volatility and potential declines. It is an attractive strategy for traders expecting rising uncertainty or bearish price trends while wanting to limit upfront costs and downside risk. However, to optimize profitability and reduce risk, it is crucial to closely monitor IV and price movements.
