Spotlight on Bitcoin Option Marketplace

On the back of considerable surge in bitcoin futures trading and the underlying price especially during course of 2017-19, the cryptocurrency exchanges are coming up with the wide ranges of derivatives products, one of them are options contracts that are eye catchy of late.

Bakkt announced offering regulated bitcoin options back in December, while CME is line up for the race by launching its own options products on bitcoin futures.

These options contracts equips traders with the right to buy or sell an agreed amount of bitcoin on a set date for a certain price, allowing traders to hedge their risk against spot and futures positions.

These option contracts will be based on the underlying CME cash-settled bitcoin futures contract. In upcoming days we may witness with the several dedicated market makers reportedly ready to support the CME bitcoin options trading mechanism.

While this would not be the first Bitcoin option contract (there are already option contracts actively traded at Derebit and LedgerX), this launch is widely anticipated given the dominance of CME in trading bitcoin futures in regulated exchanges.

Admittedly, ICE and Bakkt also introduced option contracts on December 9th 2019 that settle into the underlying physically-delivered monthly futures contract. The ICE and Bakkt launched a month ago represented the advent of centrally-cleared bitcoin options on a regulated U.S. exchange, a remarkable milestone for the crypto-derivatives market, while the option volumes and open interest have so far been rather small.

Even the cash-settled futures contracts traded at ICE/Bakkt, also launched on Dec 9th 2019, have failed so far to achieve significant volumes.

So far, any decent bitcoin option activity has been focused on less regulated exchanges, primarily Derebit and to a lesser extent LedgerX.

Nevertheless, we have noted the gradual maturing of the cryptocurrency space as the influence of institutional investors has grown in the aftermath of the listing of bitcoin futures since Dec 2017.

Although the initial trading volumes were tepid that carry echoes of the initial listing of cash-settled bitcoin futures by the CME and CBOE in December 2017. The initial volumes were low (refer above chart), but the open interest kept growing steadily. The listing of the CME futures coincided with all-time highs in bitcoin prices, and researchers at the San Francisco Fed suggested that by providing a market where bearish positions could be more readily expressed the listing of these futures contributed to the reversal of bitcoin price dynamics.

In a similar vein, it may be that the listing of options on futures contracts (that enables some holders of these options or physical bitcoin (in case of Bakkt) for instance, miners to hedge their exposures) that has contributed to recent price rallies, rather than the low initial volumes.

Bitcoin miners are also uniquely positioned to benefit by using options to secure a price for selling mined bitcoin to lock in future revenue — just like owners of olive presses in ancient Greece used the first options contracts to ensure they didn't lose out on earnings in the event of a bad harvest.

The prime merit that options offers us is the ability to tap into the collective wisdom of the market. This is attained by measuring & interpreting the ‘Implied Volatility (IV)’ — an options term that reflects the market's expectations about a certain asset.

We have got UK-based crypto research company by the name of ‘Skew’ who have put this metric to use in an attempt to end the debate over whether or not the 2020 Bitcoin halving is already priced in.

The prime objective of derivatives instruments is to provide effective hedging vehicles, but now serve as benchmarks established by a trusted price discovery process which investors can rely upon.

For price discovery, the need of beta-testing before launch is also done by bitcoin. In the recent past, Bakkt has assiduously succeeded user acceptance testing for its bitcoin futures listed and traded at ICE Futures U.S. and cleared at ICE Clear US.

Such process of price discovery unfolding before our eyes, as there has been volatile swings observed, the competition between digital currencies at the different crypto-exchanges exist, and so is the case with the derivatives products as well such as CME BTC Options.

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