Market Update: 10 Aug 2021
A bullish self-reinforcing cycle seems to have developed in ETH. The dynamic is as follows:
1. ETH spot rallied, pricing in the impact of EIP-1559. (85% price increase from the 1718 low in July)
2. The sharp move higher has reignited interest from speculators who are no longer just trading with leverage on ETH, BTC and altcoins. NFTs are the new speculative darling.
3. The trading volume in NFTs has been incredible, surpassing any other ETH transaction venue now including Defi and Stablecoin flow (Chart 1).
4. This has led to a greater burn rate on ETH, spurring further price appreciation which in turn encourages more interest and speculation.
While this ETH move and overall crypto move higher has been positive for us, we remain wary of potential downside risks on the horizon. Recall our market update from 8 July:
“…we expect a dampened trading environment from here to Aug (short vol), followed by a rally possibly on the back of the EIP-1559 mainnet implementation (long spot, long calls), and then the larger Q4 Wave 5 selloff on the Fed’s taper (sell spot, buy downside risk reversals).”
And also our historical price analog (Chart 2) which anticipates downside pressure following a sharp rally.
With the recent hawkish Fed speak and strong US data (particularly US CPI tomorrow), could the indication of tapering from the Fed be the trigger for a sell-off?
We are unsure.
We are also increasingly uncertain about how crypto prices would be impacted by macro forces given the idiosyncratic divergences between BTC and macro assets such as Gold (Chart 3 — historically 62% positive correlation).
So we remain long delta but we have been buying downside gamma for protection.
In options, the frenzied buying of calls in both BTC and ETH across the curve has resulted in a short squeeze (in both spot and vols). We think this flow comes from funds and large speculators making large topside bets, buying BTC strikes up to 80–100k and ETH strikes up to 8–10k from as early as September 2021 out to June 2022.
This has pushed implieds in BTC from around 80% end-July to about 100% now (Chart 4) and in ETH from around 100% to 120% now (Chart 5). A substantial move.
The market was clearly caught offside on this vol move as liquidity deteriorated with market makers clearly shading prices to the buy side. The QCP desk was on the other side on a good part of the vol buying so we’ve taken some pain on our short vol position as well.
Interestingly enough, realised vol has not picked up substantially on this move (Chart 6) and skew remains relatively muted (Chart 7).
We maintain our short vol view. In fact, vega (longer dated puts and calls) looks like a good sell at these elevated levels.
