Market Update: 15 Feb 2021
It was exactly a year ago today, on Valentine’s day 2020 that the market topped and eventually bled into the March 12th Black Thursday sell-off. A lot has changed in the year since — one of the most important being the unprecedented amount of liquidity global central banks have pumped into the system, single-handedly lifting every financial asset to record proportions (Chart 1).
We have witnessed the largest and swiftest asset price inflation in world history, and with it also the biggest disconnect between markets and the real economy in modern times. Evidence of this is the real estate market, supposedly the most rooted of all assets in the real economy, breaking all-time record after record in most global cities even as economies teeter on the brink of recession.
Against this backdrop it’s easy to understand how crypto, a super speculative instrument class, has itself had the most mind-boggling 13x rally this past year (Chart 2). It’s clear that regardless of how this liquidity finds its way into the crypto market — be it retail investors, hedge funds or corporate institutions, the underlying driver of this is the wall of cheap liquidity.
The channel through which this liquidity enters the crypto market determines the nature of the price move — retail investors have far less sticky capital and generate shorter-term two-way markets; while hedge funds tend to have larger allocations and comparatively stickier capital, generating longer lasting moves. Corporates and other similar institutions however are the slow moving behemoths that allocate and deploy slowly but will drive a long lasting multi-year trend. With the increased adoption across all segments of the market, the many layers of asset managers from mutual funds, ETPs, up to sovereign wealth funds represent derivatives between the hedge fund and corporate classification. Central banks of course remain the holy grail, but are a remote possibility apart from a few small insignificant ones.
Given the relatively small market size and the increased adoption across all market segments, the BTC price today is not unreasonable as long as the central banks keep printing. For us the “bubble” is not so much the current price of BTC itself, but rather the market’s projections of future BTC price. It was estimated by an asset manager that if all the S&P 500 companies allocated 10% of their cash piles to BTC today it would send the BTC price to $400,000. Putting that with Bridgewater’s forecast of BTC price assuming half the Gold speculators switch to BTC today ($160,000 forecast), we can see how rich the backend BTC calls are (Chart 3).
Put simply, the market is pricing a 10% chance of $400,000 by year’s end, 15% chance of $300,000, 30% chance of $160,000 and close to a 50/50 chance of higher than $100,000. In our view the curves are too steep and the long-term implied vols are too high, but this combination is also the reason for the incredible market-neutral yields that are available in crypto and nowhere else. With the development of large-scale publicly listed corporates joining the fold (meaning quick access to potential capital raises a la Microstrategy), focusing on earning BTC theta (especially downside) could be a decent play.
In the near-term however, we have to trade between the 3 segments of market participants — retail, hedge funds and corporates. We continue to see the retail chase and get stopped out on any short-term momentum breaks, and this can extend into a quick $3,000-$5,000 washout like the one we had this morning, and why we like gamma around here. For hedge funds and large quants, we expect them to be leaning heavily on the parabolic that has supported this rally since Oct (Chart 4).
To break the 50k we need a fresh large corporate involvement, and we like selling theta into this on the expectation that large scale decisions will take some time. As a specific structure we like a long end-Mar 48k/56k 1x2 call spread for positive premium, with the intention to trade the gamma on the 48k call down to 42k & 40k potentially multiple times. With every rally thus far having been matched with an even steeper futures basis, this also gives us confidence in shorting near-date higher delta calls outright due its ease in rolling higher on any breakouts. For ETH we continue to watch the trendline that has supported us since the upward move from $600 in Dec, and we like selling higher delta shorter-date puts to chase this trend higher until the trendline breaks (Chart 5).
Nevertheless the longer BTC stalls here without a fresh catalyst, the more we will be looking for a longer lasting downside into March. As we’ve highlighted before the March downside seasonality followed by April upside seasonality is the strongest and most consistent seasonal pattern in BTC and likely to be tax related (Chart 6). With the increase in global crypto tax regulation this will likely further solidify this seasonality going forward. It’s still too early now for us but into end-Feb if vols drop further we will be looking for some end-Mar downside protection.