Market Update: 5 Jan 2022
Two of our key views from our 2021 year-end research piece (https://docsend.com/view/g7nx3g54tyante7j) have come into play a lot quicker than expected:
1. Significant softening of vols
2. Outperformance of ‘laggard’ layer 1s
The hard dip in vols, especially in ETH, has been truly surprising. 1-month vols in ETH have collapsed to 60+%, a stunning drop from over 95% just two weeks ago!
BTC vols have fallen as well, though not quite as dramatically. Front end vols in BTC and ETH are now almost at par (Chart 1).
The most obvious explanation for this phenomenon in ETH vols is the sudden influx of Altcoin vol supply from the Defi Options Vaults (DOVs) especially with the launch of three Solana-based DOVs in the last two weeks.
With no vol market for the Alts, market makers resort to selling ETH vol as a proxy hedge for their Altcoin gamma positions (short-tenor options).
We know this first-hand having scooped up a large part of the Altcoin gamma from the DOVs and paying a painfully expensive decay bill over the last two weeks.
(For those who think the DOVs are an easy arb for market makers, I wish it were true! Managing the cost of long gamma has been very challenging with sleepy spot moves. But this also means great return for option sellers.)
Our view is that this vol compression is structural and will be a theme for 2022. With that said, we think this dip in the front-end is overextended and we’re adding long gamma here.
Some of the layer 1 coins have outperformed for us having kept long delta (long spot). While BTC has barely moved, NEAR, ATOM and FTM have been the early winners of 2022 (NEAR +32.5%, ATOM +48.7%, +46.2%).
Again, we think this theme continues for the rest of the year and we are keeping long delta on these and other layer 1s with potential for exponential upside.
View-wise, we are still holding out for an upside move in the near-term. Looking at the 10-year breakeven inflation rate (which has historically had a high correlation with BTC), there has been a material divergence since end-December (Chart 2). If BTC plays catch up here we could see the move towards 60,000.
Our positions remain fairly nimble with long gamma, short vega (in BTC and ETH) and biased long delta in the major layer 1s.