Bitcoin ETF Options: The Game-Changer Investors Can’t Ignore (Part II)
Responding to key investor questions, this essay delves deeper into why Bitcoin ETF options are transformative for capital efficiency, volatility, and market dynamics.
This is Part II to my short essay on Bitcoin ETF options. As many informed investors responded to my original post with further questions, I compiled a few of the most important ones to provide further clarity into why I continue to believe that Bitcoin ETF options are game-changing. Here were the top three:
“We already have Bitcoin options in Deribit, LedgerX, CME etc. so this is not significant”
With all due respect, nobody cares about LedgerX, Deribit, exchanges without central guarantors. Even with a fairly conservative margin engine on CME futures (24% MM), nobody cares about CME futures options either; it’s what I call a “fiction of a fiction” product. People always want the real thing. And there is actually a well-founded reason for this too: BTC ETF options will have cross-margining capabilities in multi-asset portfolios that Deribit, a single-asset exchange, can never provide. Only spot ETF options can leverage your GLD, SPY, HYG ETFs, bonds, loans, and cross-margin to achieve unmatched capital efficiency - closest thing that looks like free leverage.
“Paper Bitcoin only allows synthetic dilution, which means volatility will likely go down as derivatives allow USD collateral holders to sell extra BTC. We don’t want it to be paper casino.”
Options are just a tool that creates synthetic flows. It doesn’t create nor destroy Bitcoin. So while derivatives allow USD holders to sell BTC “exposure,” that synthetic trade has an opposing side. The profits and losses are a zero-sum game. However, the path of Bitcoin’s destination is not a zero sum game; it is an open-ended journey of a flow (not state) asset. With options in particular, volatility is reduced in the system when investors are selling volatility. In that scenario that investors are engaged in only selling covered calls, I would agree that this would be volatility-reducing.
But, how does volatility get introduced? Dealers have to get short gamma, which means real money is buying puts or buying calls. Here, I will explain the asymmetry of the modern day rules-based maintenance margin machine.
Margin for Long calls and puts are easy - it’s just the premium. This is because buyers can only lose as much as the premium spent, and potentially seek unlimited/significant profit.
Margins for Short calls and puts are not - there is a dynamic calculation that uses the strike price, spot price, and how out of the money it is. That’s because being short option exposes you to unlimited/significant losses. But here is the critical subtlety: 1) the formula does not have “volatility” as an input. This means a 10% OTM call option, whether the stock’s vol is 5% or 50% is treated the same! and 2) the formula makes no adjustment for contract duration. This means a 3m option and a 1y option, all things considered, are treated the same! Both create room for financing arbitrage
In other words, selling calls are fundamentally capital intensive. Buying calls are not. Unlike futures, options MM is not only asymmetrical by nature, it also favors bettors of very improbable and long-dated events.
“You can’t short squeeze a trillion dollar asset”
So that brings to my third point. If you assume that structural leverage is biased to one side of the market, then practitioners will take advantage of this arbitrage. Options do not create “money value” - it creates “money velocity.”
And the multiplier effect of that delta is extreme. Take for example the Sep25 $200k EC on Deribit today, which is 10 delta, and costs $1400 (0.02 BTC) at time of writing. The recently introduced BFF contracts by CME has a unit size of 0.02 BTC as well, with only 1 week expiry. For the same capital outlay, there is ~25% more delta on the option than the futures Day1, which can also potentially be 10x over the year. What do you think has more embedded leverage?
With a leveraged contract on an asset, you can squeeze anything. Saying you can't short squeeze a trillion-dollar asset is like saying you can't make an elephant dance. Sure, the elephant’s huge, but if you tie enough ropes to its legs and pull hard enough, even the biggest creature can be made to move in ways it doesn’t want to. It’s all about where and how you apply the pressure.
And remember my first point on “free leverage” from cross collateralization? In the end, it’s ETF options are the tight ropes accelerating flows that change Bitcoin's potential energy to kinetic energy, which all leads to one path:
Higher.