Bitcoin’s ‘Volatility Smile’ Shows Increased Demand for Bullish Exposure

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The recent double-digit rally in Bitcoin (BTC) has sparked a shift in positive sentiment among crypto options traders.

The leading cryptocurrency by market value has gained 13% this month, topping the $19,000 mark for the first time since Nov. 8, according to data from CoinDesk.

Falling US inflation, a weaker US Dollar and expectations of a slowdown in Federal Reserve rate hikes have helped the cryptocurrency look past the lingering fallout from the FTX meltdown.

And in line with the resilient rally, the bitcoin options “volatility smile” shows that the demand for out-of-the-money (OTM) call options bullish bets on strikes above the current market price of the cryptocurrency has increased compared to puts or bearish bets.

“BTC’s short-term OTM calls have seen an increase in implied volatility relative to OTM puts. This continues the trend from the volatility smile to a more neutral smile, which was previously driven by lower demand for downside protection [puts] throughout December,” Andrew Melville, a research analyst at crypto derivatives analytics firm Block Scholes, wrote in a note released Thursday.

“This indicates that the BTC derivatives market is no longer just pricing in lower bearish sentiment, but also reflects an increase in demand for exposure to upside moves,” Melville added.

The bullish shift perhaps reflects the confidence of sophisticated market participants that bitcoin’s rally to two-month highs could be just the first milestone in its upward trajectory.

The volatile smile is a graphical representation of the implied volatility of a series of bullish call options and bearish put options at different strike prices, but with the same underlying and the same expiration date . Implied volatility (IV) or projected volatility is the market’s expectation of future price turbulence of the underlying asset and is directly influenced by the supply and demand of call and put options.

A U-shaped line is formed sloping upwards at both ends, which looks like a smile, when IVs for options at different strike prices are drawn. The simplest explanation for the U-shape is that demand for out-of-the-money (OTM) and in-the-money (ITM) call and put options is generally higher than for call and put options. parity sale (ATM). options, as Patrick Boyle and Jesse McDougall wrote in the book “Trading and Pricing Financial Derivatives”.

The story continues

Call options above the current market price of BTC, currently $18,850, are called OTM, while those below the spot price are ITM. The reverse is the case for put options, with options above the spot price called ITM while those below called OTM. Call and put options on strikes around the spot price are ATM options.

Bitcoin’s Volatility Smile

The bias of smiling has disappeared, implying an ebb of fears in the market.

The Block Scholes chart shows bitcoin’s 30-day volatility smile on December 5 (blue line), January 6 (grey line), and January 12 (yellow line).

On Dec. 6, the volatile smirk looked more like a smirk, with higher implied volatility on options at lower strike prices, a sign of stronger demand for downside protection.

The smirk had since faded due to a drop in demand for put options and an increase in call demand.

“Last week, we reported that the move towards a more neutral volatility smile for BTC was due to a decline in the OTM put IV rather than an increase in the OTM call IV. the same time, we noted that a drop in the implied theft across all strikes saw the implied volatility across the whole smile drop,” Melville noted.

“Since then, we have seen an increase in the IV of OTM calls to the same levels they recorded in early December. However, OTM put options remained at their lower levels, resulting in a reduction in the bias of smile,” Melville added. .

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