Hi readers, In today's newsletter, Dennis Ehlert of AMINA Bank writes about the maturing crypto options market, aiding investors in implementing customized strategies for hedging, leverage, and yield generation while enhancing market sentiment analysis. Then, Glenn Rosenberg of ML Tech investigates potential market opportunities between owning MSTR and BTC, given bitcoin's post-election bump and MSTR's significant drop due to short selling concerns. Thanks for joining us. |
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Crypto Options: A Key Tool for Institutions Navigating Volatility and Yield |
As the cryptocurrency market matures, driven by growing institutional, corporate, and possibly governmental adoption, the role of the crypto options market is becoming increasingly crucial. This segment helps investors deploy tailored strategies for hedging, leverage, and yield generation while providing deeper insights into market sentiment. Crypto options markets are primarily divided into centralized exchanges and the over-the-counter (OTC) market. Recent open interest data from platforms like Deribit, CME and OKX reveals that total listed bitcoin options reached new heights in late November, surpassing USD 40 billion. However, ether options remain relatively underwhelming, with open interest totalling just USD 9.8 billion, down from a peak of USD 14.5 billion in March. Deribit, the leading platform for bitcoin, ether, and altcoin options, dominates the space, accounting for nearly 90% of the total open interest. The open interest data on Deribit paints a picture of a positive outlook in bitcoin options. With over USD 19 billion in call options versus USD 9.4 billion in puts at the beginning of December, the market is clearly positioning for continued upward movement. A significant portion of this open interest — USD 5 billion — is concentrated in call options with strike prices between USD 100,000 and USD 120,000, expiring in December and March 2024 [source: Deribit]. The pronounced Call-Put skew [e.g. 25D 1month +5% on December 2nd], where out-of-the-money calls carry higher implied volatility premiums than puts, indicates strong demand for leverage over downside protection. Centralized exchanges, with their user-friendly platforms and transparent real-time data, offer individual investors insight into market sentiment through trading activity, order flow, and liquidity. However, institutional investors are increasingly turning to the crypto OTC market for more customized solutions, greater privacy, and the ability to execute larger-volume trades. Many of these OTC deals are governed by master agreements such as the ISDA Master Agreement and Credit Support Annex (CSA), which allow for highly tailored trades with flexible strike prices, expiration dates and collateral management terms. Trading with regulated entities: a gateway for institutional investors For institutional investors aiming to deploy bespoke options strategies and invest in yield-generating products, trading OTC options with a regulated entity is often the preferred route. Regulated counterparties provide a structured, transparent framework that minimizes counterparty risk and ensures compliance with legal and regulatory standards. Through this approach, institutions can execute large trades without the constraints typically found in the more public and less flexible centralized exchange environment. Furthermore, the use of master agreements in OTC transactions offers significant advantages in terms of risk management and flexibility. These agreements enable institutions to customize the terms of their trades — such as the choice of strike prices, expiration dates, and collateral arrangements — while minimizing credit exposure through robust due diligence processes. As institutional demand for sophisticated options strategies continues to grow, regulated OTC counterparties will play an increasingly pivotal role, offering liquidity, security, and the capacity to manage large positions in an efficient and customized manner. |
- Dennis Ehlert, executive director for crypto derivatives trading, AMINA Bank |
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After the election, as everyone except for muggles know, the price of BTC rallied to all time highs (ATH) just short of $100,000. At the time of this writing, it's hovering around $98,000. An interesting question then is: what happened to Michael Saylor's MicroStrategy (MSTR) during this period? The publicly traded stock, synonymous with its unconventional and risk-on co-founder as well as the price of BTC, also rallied to post-election ATH — as one might expect — exceeding $500. Then last week, it took a precipitous ~22% short selling-inspired hit based off of a report expressing concerns about the company's valuation. The noise around the stock piqued my interest. I was curious to dig in and see what potential market opportunities might exist, or at least understand the value of owning MSTR vs BTC. |
This graph is a bit misleading. The main reason MSTR has outsized gains to BTC is that MSTR is highly levered. Very highly levered. It has acquired 386,700 BTC for nearly $22 billion, which represents an unsurprising ~99.5% of its balance sheet. To achieve this, the company has raised $9 billion in debt, some with zero interest. If their BTC holdings are collateralized by this debt, they could face a challenging repayment in a severe BTC downturn. They also raised $4.6 billion in equity for these BTC purchases. With an average BTC price of ~$56,500, appreciation factors heavily into the market cap. The correlation between MSTR and BTC is relatively high, using both Pearson and Spearman correlation coefficients, at about 65% using 12 months of daily closing price data. Remove leverage and the correlation is pretty linear. Generally, follow the price of BTC and the price of MSTR will follow. The correlation is strong, but not so strong for several reasons. MSTR runs a very profitable business intelligence (BI) operation that generates annual revenues around $500 million. This makes it one of the largest players in the BI space. It's a stock with a real business and prone to price moves based on the underlying business. BTC leverage is the key though, creating a 2.5x volatility to BTC. |
Arguably, MSTR is not a good proxy for BTC and unless you're comfortable with the increased leverage and volatility, it's also not a comfortable investment opportunity. Just buy a BTC ETF. You can leverage BTC perpetual contracts or BTC ETFs to get a similar risk profile to MSTR. But if you want the leverage, it's probably better to let Michael Saylor take the risk and as an investor, just own the price risk. But it isn't a replacement. Given the strong correlation and MSTR's oversized exposure to BTC, is there a trade here? Let's look at mean reversion. The dramatic MSTR rally before its big drop last week pushed the z-score to nearly four standard deviations (4σ). Looking at the graph, however, historically there haven't been many mean reverting opportunities. A large part of this can be attributed to the recent use of leverage to add to its position, so the relationship between the two assets is now much different than before. MSTR has the ability to sell another ~13 million in equity, which could widen the ratio further. One can conclude that MSTR is significantly overvalued to BTC and an even further narrowing of the spread could occur. |
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