If ain't broke... break it!
Week ending 10/4
Hi All,
So based on responses and lack of responses, maybe last week’s title was a bit too aggressive. Well, as we all should say in both trading and life after a mistake: “That trade is over!” The key is to both put it behind and keep it in mind to make the future better (process, baby!). With that in mind, I’m going to quote Harley Bassman quoting David Rosenberg (for the coders, recursion baby!):
“Cycles die; and do you know how they die? The Fed puts a bullet in its forehead.” - David Rosenberg
Harley’s piece, titled “Crash Test Dummies” pulls no punches either on his missed-it-missive “Soft Landing” from September 7 (“line your bird cage” with it), to mocking Team Transitory, and stating that the Fed has just “purchased a berth on the Titanic after it hit the iceberg.” Only my 18 year old daughter could be more caustic (she has a ridiculously on-point sense of humor that spares no one). Harley points, like many others, to a housing market that is both currently hurting and about to crater. Twitter and blogs are awash with mortgage math porn (mortgage payment of X used to buy an $800K home and now can only buy a $500K home).
Obviously this is not the only area that is breaking. Credit Suisse and Deutsche Bank appear to be having issues. The UK gilt market had a bit of hiccup — was that higher rates or an unloved tax package? I think it is very reasonable to argue that it was both. Less liquidity in the system converted something that may have been a tempest in a teacup turned out to be a 25 std dev event.
Meanwhile BTC and ETH volatility just stagnate. BTC 7 day realized vol is … 27%?! That’s below the VIX value of 29. What gives? How is that possible when rates volatility is through the roof and silver jumps 9% on Monday (yes, I’m cherry picking that data point)? Meanwhile the DXY has dropped from 114 to 110 in one week. It’s like Wall Street has its own problems and no one has time for crypto.
With all of this talk of breaking, as noted above, it is actually the USD that has done the actual breaking over the past week. And assets have followed through. If realized and implied volatility for BTC could not catch a bid with the USD hitting 20 year highs, two European banks calling press conferences to tell us “it is all ok. really” and a UK gilt crisis, what chance do we have for volatility if financial conditions ease up?
Which brings me to the conversation I had yesterday with a friend about the volatility outlook. He asked me whether BTC volatility could hit into the 20s. He notes the following:
There was no crisis and no follow through on the latest move down. Conclusion is that there is not a market wide levered long position in place to cause downside chaos.
The crypto world benefits from higher values for crypto assets, i.e., there will be sellers on rallies — sellers of calls, sellers of spot, buyers of puts. Crypto has turned into more of a supply market (like stocks & bonds where there is a “supply” of assets held by investors) rather than a symmetrical market (think FX), or a demand market (like energy or, these days, orange juice).
A brand new supply of crypto options traders that have only traded a short period of time and are “data-driven.” But what if the future is not like the past? Or like the past but one or two regimes ago? And what will hurt the most for options traders: a crushing and sustained low volatility environment.
These two factors will end up keeping BTC and crypto as an asset class in a range — or at least slow-bound. I don’t know if anyone has used the term slow-bound before but I mean it to be not necessarily range bound, but where the underlying moves are subdued enough to be painful for long gamma. I’ve been in those environments and they are very tough. I remember trading Microsoft options a long time ago and we hit a slow patch in volatility. One of the larger traders in the crowd turned around saying, “It’s like driving to work each day in a brand new mid-level sports car and then just leaving it there in the parking lot to walk home.”
One thing both of us agreed on is that if something like that happens, the price is going to drive the narrative and not the other way around. First, things are going to be cheap. It is going to look great on a statistical basis. “One month is in the lowest quintile of vol.” And the grind of no movement will just go on. Only later will a narrative emerge on what the real reason is.
Still, I’ll take a stab at that now. As I’ve discussed before in numerous pieces, including “I Just Can’t” a lot of what drives BTC/USD pricing is USD. That’s not surprising as it is the denominator. So if we think about a decomposition into what bitcoin is/represents, one part of that is 1/USD or an anti-dollar. The second part of it is the technology and utility of bitcoin (Arthur Hayes thinks similarly and discusses that a bit in snippets). How valuable is it as a payment system. But this is a bit strange because no one thinks about fiat in that way. USD is just something of a doorway to USD assets (and, also, a potential store of value). There are other aspects to dollars, too, because of the ease in which money can be raised and therefore there are mega-large dollar shorts in the world — that is to say sovereigns and corporates who borrow in USD (without swapping out of the currency risk). But no one buys USD because SWIFT is a great payment system. I think that there is a good argument that bitcoin develops into a currency-payment system (say because of geopolitical tensions and the utility of having a third party currency that is not gold) and the technology is a sideshow. If so, there then is a good argument that the volatility of such currency looks more like (shocker) currency volatility rather than 80-100%. Also, if that does occur, expect that the 21 million bitcoin ceiling to expand as such a dramatically hard currency does not tend to function well.
What might that look like? Gold, an asset the Digital Gamma team is familiar with, is something like 2X major currency vol. Something in the 10-20 range typically. Does BTC become a 3X major or a 2X gold? That would put it in the 20-40 range. Or does the regime flip back to historical BTC levels? That’s harder to envision. I suspect that if that occurs, then it will be due to movement up — at least for now. Crypto had a massive deleveraging event so we are running clean right now. Like my wise friend, I don’t see emergencies at the moment to the up or the downside — not 100 vol emergencies anyway.
What’s actionable? Calls are better bid, puts are better offered. Vol is expensive vs realized. And if you are a paranoid type, non-farm payrolls are on Friday. The best “Plaza Accord” to weaken the Dollar would be for a weak print on NFP. The bear market rally would be intense especially on a Friday. “Show me the incentives and I’ll show you the outcome.” Just sayn. All in, the set up favors long delta, short premium. Sizing and how to position appropriately are key.
Things I’m reading / listening / watching:
Harley Bassman’s latest
Harel Jacobson on “Flirting With Models”. Check out the podcast and the two medium blog pieces.
I’m working on my meditation game because I’m not perfect. Besides the paid apps, etc, UCLA seems to have a good offering of free (and paid) resources. I’ll need to complement this with the Stoics, but as my twitter profile says “left foot, right foot”. One thing at a time.
Tell me (how) I’m wrong,
Ari
DISCLAIMER: Do your own research. Nothing herein is investment or trading advice. All information here is given on a best efforts basis and there is no guarantee of accuracy. Digital Gamma or the author may or may not have positions in the assets or their derivatives mentioned herein.