Is the option market, which suffered a shrinking trading volume at the beginning of the year, still worth watching?

Written by: Pan Zhixiong, Director of Research

Source: Chain News

In 2019, cryptocurrency exchanges usher in a new type of trading contract: options . Although from the perspective of transaction volume, the market has not yet attracted much attention. For example, the option trading volume on the US compliance derivatives exchange Bakkt was 0 in the last week, which is really ridiculous. After all, this is a new type of trading with a threshold. , But in fact it is very important for the cryptocurrency trading ecosystem.

There are four basic types of derivatives in the financial industry: forwards, futures, options and swaps. Apart from non-standardized forward contracts and currency market swap contracts, the most important are futures and options . If the cryptocurrency trading market is also an extension of a financial market, especially commodity trading, then futures and options are also quite basic and important for cryptocurrency trading. Futures contracts have spread across many mainstream cryptocurrency exchanges, and options are still a new thing for the cryptocurrency trading ecosystem.

What are options?

Options originated in the United States and European markets in the late eighteenth century, and the contract gave the holder the right to buy or sell an asset at a fixed price at any time before or a certain date. A common example is that Bitcoin miners and institutions that hold Bitcoin assets can use such tools for hedging, and of course, many people use such tools for price speculation.

For many cryptocurrency traders, futures should be the most commonly used and easy-to-understand trading derivatives in previous years. Compared to spot trading, traders need to learn the concept of margin and delivery time. Options are more complicated and have a certain learning cost. After all, the option pricing model has won the Nobel Prize in Economics in 1997, so this is not a simple and commonly used concept .

Deribit's Options Tutorial

If you understand the difference between spot trading, futures trading and options trading in the fastest way, this can be explained as follows:

Spot Trading

Can be understood as: (who) at (what price) (buy / sell) (how many) (what assets)

Example: Satoshi Nakamoto bought 1 Bitcoin for 9,000 USD.

Futures trading

Compared with the spot, two additional concepts are added, namely: (in how much margin) and (at what time)

For example: Satoshi Omoto plans to buy 1 bitcoin for US $ 9,000, but currently only uses US $ 1,000 in deposits, which can only be delivered on June 26, 2020. (In this case, Satoshi Aumoto's leverage was 9 times.)

Options trading

Options trading is more complicated than futures. Generally there is no margin mechanism, but the concepts of exercise price and option direction are added, that is: (who) at (what price) (buy / sell) (how many) to (How much exercise price) (call / put) (what asset) (at what time)

For example: Vitalik Buterin pays 1 USD for a call option of 200 USD that is exercised on Ethereum and delivered on June 26, 2020. (This also means that he has "the right to buy 1 ETH for $ 200" when he exercises the option, but he can also choose not to exercise the option and lose this right, which means that he only loses $ 1.)

The above case actually simplifies many concepts, such as details of rates, European / American options, etc. It is also because options are more complex and contain more parameters, so traders can build more complex trading strategies through options. So traders' demand for options is still very clear. Not only can they speculate on future prices, they can also arbitrage or build hedging strategies.

Why do you need options?

Many people may not understand that in the traditional financial market, the market size of derivatives is much larger than the spot market. According to statistics from the Bank for International Settlements (BIS), the nominal value of the global derivatives market exceeds US $ 500 trillion, which is far more than the total value of the global real estate market of 217 trillion.

From the perspective of market structure, derivatives will enrich the trading variety of the entire market, and professional investors and hedge funds can participate in it, each taking what they need. More professional scholars believe that as the derivatives market matures, it will help the underlying assets stabilize prices, especially for options.

There are only two core trading motivations for options, speculation and hedging . Although similar to futures, because the contract design of the two is different, the strategies that need to be constructed when trading are completely different. More importantly, option products are more complex and the contract granularity is higher, so traders can adopt more complex strategies and have more choices.

A very simple example, if a bitcoin miner wants to hedge the bitcoin price in June on Deribit, he can choose to trade in 1 futures market for June delivery, or can choose to go for 38 in June delivery. Options market. Futures and options may differ by dozens of times in the number of trading markets .

OKEx's Options Contract Market

It is also because options are more complicated and more options, so option trading participants are mainly professional players. In addition to market makers that provide liquidity, it mainly includes institutional investors, hedge funds, miners, speculators, and so on.

In addition, options are one of the important foundations of other more complex derivatives, such as the well-known panic index . Because options can also represent a trader's prediction of commodity prices, if these transaction data are indexed, the future fluctuations of the underlying assets can be predicted, so they can also be called implicit volatility indexes. Some professional investors will conduct higher latitude risk hedging strategies based on the tradable panic index.

Options trading fully launched in 2019

Before 2019, Bitcoin had few places to trade options, the most famous of which was Derivit, a Dutch derivatives exchange. Although BitMEX, a well-known perpetual contract, has also launched similar products, the transaction volume and liquidity have not improved, and it has been offline.

With the development of the bitcoin futures contract market, more and more exchanges announced in 2019 that they will launch option products. The mainstream include LedgerX, Bakkt, OKEx, CME, and Binance acquired JEX, and even Canadian listed cryptocurrency investments. Bank Galaxy Digital also announced the launch of options trading in the middle of last year.

Derwent data analysis platform Skew currently collects option transaction data for five platforms, of which Galaxy Digital has not disclosed relevant data and has not yet included JEX. It can be seen that most of the current trading volume of bitcoin options is concentrated in Deribit, and since OKEx launched the option contract, it has replaced LedgerX's second place. The recent CME and Bakkt trading volume is 0.

Advantages of compliance agencies

Among these institutions, Bakkt, CME, LedgerX, and Galaxy Digital are clearly following the compliance route. The first three have US derivative trading licenses, and the last is a Canadian listed company. The advantage of these companies is that they can provide services for traditional "old money", that is, institutional investors from Wall Street.

Take Bakkt as an example. Its parent company, the Intercontinental Exchange Group's New York Stock Exchange and other derivatives exchanges, has a large number of brokers or brokerage ecosystems, and those brokers can naturally invest former institutional investors and professional investors. This led to Bakkt, offering them futures and options trades in alternative assets such as Bitcoin. After all, for them, transaction volume means revenue and profit.

Not only that, Bakkt's equity investors also include traditional financial proprietary dealers and liquidity providers Eagle Seven, which means that Bakkt's liquidity will not become a bottleneck limiting exchange expansion.

Advantages of other institutions

OKEx, Binance JEX, and Deribit are not yet able to provide options trading for US users, but can serve most other regions. Because they are not restricted by US regulators, the product design of such trading platforms can be more flexible and the threshold for end users is not so high. Therefore, for ordinary retail investors, such exchanges may be more suitable.

Among them, Deribit's first-mover advantage is still very clear. As one of the oldest bitcoin options exchanges, Deribit currently accounts for almost the entire trading volume of the entire options market. Based on the data collected by Derek, a derivatives data analysis platform, whether Judging from the volume of options traded and open contracts, Deribit is far ahead of OKEx and LedgerX. This means that the liquidity and participants of option trading in the entire market are mainly concentrated in Deribit.

Open interest data of bitcoin options contracts in five recent platforms

OKEx's advantage is the delivery of futures, while Binance's advantage is in the liquidity of spot transactions. For them, they have a lot of retail traffic in the cryptocurrency market. The more important strategy may be option education and access to more option market makers to improve liquidity.

The key to 2020 is liquidity

Before 2020, the liquidity of cryptocurrency options was concentrated in Deribit, but it was still not enough. For example, the trading department of Galaxy Digital provides institutional-level services. The main users include hedge funds, family offices, and high-net-worth individuals. Their demand for liquidity can be imagined.

Comparison of market value, transaction volume of cryptocurrency market and traditional financial market compiled by Galaxy Digital

Like traditional financial markets, the market size of derivatives should be larger than the market size of the underlying assets. At present, there is still a gap in the trading of cryptocurrencies. The daily trading volume of Deribit's bitcoin options contracts is also several thousand. Based on the price of 1 BTC per contract, the nominal trading volume is almost 10 million US dollars. The daily trading volume of the Binance BTC / USDT spot trading pair is hundreds of millions of dollars, not to mention that there are so many other exchanges and trading pairs.

Ran, the chief operating officer of quantitative investment research institution Kronos Research, once told Lianwen that although Kronos' daily transaction volume exceeded 1 billion U.S. dollars in the near future, the overall market size still limits the capacity and transaction volume of Kronos strategy. Quantitative funds, such as Jump Trading and Tower, already have their own cryptocurrency quantification team, but market compliance and liquidity issues still limit the speed of traditional institutions' admission.

It is optimistic that traditional quantitative funds, market makers, and self-employed companies are accelerating their entry into this industry. Because the issue of compliance has been gradually resolved, both the derivatives trading license and the fund custody license have made great progress in 2019. Investors like Jump Trading, Tower, Bakkt, Eagle Seven, etc. mentioned above, coupled with the trading ecosystem partners of Intercontinental Exchange Group and CME Group in the financial field, it is foreseeable that there will be more and more in 2020 Institutions like this have entered this ecosystem and injected more liquidity into the derivatives market. After all, Bitcoin is just an alternative tradable commodity for them.