Would a modern options and derivatives market reduce or increase volatility?

[Este Nuno]

In another thread on here people were talking about hedging bitcoin with derivatives and it made me wonder what sort of effect they would have on bitcoin if we had a robust market for those types of financial instruments.

What do you think?

[1715349940]

1715349940

[twiifm]

I can't comment about futures but I trade options.

With stocks, the volatility is not because of options.  Its because of the underlying product. 

But what options affect is liquidity.  Options market makers have to do something called "delta hedging".  When they write options (puts or calls) they have to long or the short the underlying product so that they are hedged against directional moves.  Because options are leveraged 100:1 the MMs are forced to buy/sell the equivalent amount of stock to stay delta hedged.  This creates liquidity because the options MMs are forced to constantly trade the stock

For example there are 2 3D stocks SSYS & DDD.  They are roughly the same in market cap.  SSYS is $5.5B & DDD is $6.1B

SSYS only has monthly options but DDD has weekly options.  If you trade both you will find that there is more liquidity in DDD.  Its much easier to get in and out of trade and the spread is tighter.  So DDD is easier for day trading scalpers to deal with

They are both similar in volatility they both had big rise (200%) and crashed (78% from top).  They both have about 40-45% monthly implied volatility

[Bogleg]

I can't comment about futures but I trade options.

With stocks, the volatility is not because of options.  Its because of the underlying product. 

But what options affect is liquidity.  Options market makers have to do something called "delta hedging".  When they write options (puts or calls) they have to long or the short the underlying product so that they are hedged against directional moves.  Because options are leveraged 100:1 the MMs are forced to buy/sell the equivalent amount of stock to stay delta hedged.  This creates liquidity because the options MMs are forced to constantly trade the stock

For example there are 2 3D stocks SSYS & DDD.  They are roughly the same in market cap.  SSYS is $5.5B & DDD is $6.1B

SSYS only has monthly options but DDD has weekly options.  If you trade both you will find that there is more liquidity in DDD.  Its much easier to get in and out of trade and the spread is tighter.  So DDD is easier for day trading scalpers to deal with

They are both similar in volatility they both had big rise (200%) and crashed (78% from top).  They both have about 40-45% monthly implied volatility

In practice, derivative increased the volatility of the underlying product because of the leverage build into them.

[twiifm]

In practice, derivative increased the volatility of the underlying product because of the leverage build into them.

No it doesn't.  It increases the liquidity as I just explained above.  The volatility has to do with the product not with the options

For example one of the biggest options market is for AAPL.  AAPL moves on average like 1% a day if even.  But look at something like TSLA that moves like avg 2% a day but often more than that

Its not because theres more options on TSLA it's because TSLA is a newer company so there's going to be more speculative trading there.

[Este Nuno]

So in reality having a solid options market would actually increase the liquidity of bitcoin but not necessarily decrease the volatility. But it's unlikely to increase the volatility, correct?

[twiifm]

So in reality having a solid options market would actually increase the liquidity of bitcoin but not necessarily decrease the volatility. But it's unlikely to increase the volatility, correct?

Correct

Think of options as side bets.   Traders use options because of leverage.   So they are not buying or selling bitcoin they are trading contracts on the side betting if bitcoin goes up or down by a certain date.

But options market makers are mostly writing the options.    Its really risky for them to do this so in order to hedge these bets they buy or sell the underlying.   Its called delta hedging.   Delta us how much the option mives w the stock.  The stock is one delta.   The more "in the money" the higher the delta.   Market makers don't care about direction.   They make money on premium and the premium is priced using volatility

When a product has options it gets traded a lot.   But its the same shares being passed back and forth by the same group of market makers.   This is why liquidity increase.   If you need to buy or sell the market maker takes your order.   You don't need to wait for a buyer or seller on other side.

[Este Nuno]

So in reality having a solid options market would actually increase the liquidity of bitcoin but not necessarily decrease the volatility. But it's unlikely to increase the volatility, correct?

Correct

Think of options as side bets.   Traders use options because of leverage.   So they are not buying or selling bitcoin they are trading contracts on the side betting if bitcoin goes up or down by a certain date.

But options market makers are mostly writing the options.    Its really risky for them to do this so in order to hedge these bets they buy or sell the underlying.   Its called delta hedging.   Delta us how much the option mives w the stock.  The stock is one delta.   The more "in the money" the higher the delta.   Market makers don't care about direction.   They make money on premium and the premium is priced using volatility

When a product has options it gets traded a lot.   But its the same shares being passed back and forth by the same group of market makers.   This is why liquidity increase.   If you need to buy or sell the market maker takes your order.   You don't need to wait for a buyer or seller on other side.

Seems like it would be a net positive for bitcoin. I wonder why there is so much resistance to the idea of bitcoin options. Misinformation maybe?

[twiifm]

So in reality having a solid options market would actually increase the liquidity of bitcoin but not necessarily decrease the volatility. But it's unlikely to increase the volatility, correct?

Correct

Think of options as side bets.   Traders use options because of leverage.   So they are not buying or selling bitcoin they are trading contracts on the side betting if bitcoin goes up or down by a certain date.

But options market makers are mostly writing the options.    Its really risky for them to do this so in order to hedge these bets they buy or sell the underlying.   Its called delta hedging.   Delta us how much the option mives w the stock.  The stock is one delta.   The more "in the money" the higher the delta.   Market makers don't care about direction.   They make money on premium and the premium is priced using volatility

When a product has options it gets traded a lot.   But its the same shares being passed back and forth by the same group of market makers.   This is why liquidity increase.   If you need to buy or sell the market maker takes your order.   You don't need to wait for a buyer or seller on other side.

Seems like it would be a net positive for bitcoin. I wonder why there is so much resistance to the idea of bitcoin options. Misinformation maybe?

I dont trade bitcoins but I looked on coinbase and the bid ask spread is $2.  That is crazy wide.   When AAPL was $600 the bid ask spread was still only 10c.

If there were options on bitcoin that increased liquidity the bid ask spread might go down to about 30c. 

[DannyElfman]

So in reality having a solid options market would actually increase the liquidity of bitcoin but not necessarily decrease the volatility. But it's unlikely to increase the volatility, correct?

Correct

Think of options as side bets.   Traders use options because of leverage.   So they are not buying or selling bitcoin they are trading contracts on the side betting if bitcoin goes up or down by a certain date.

But options market makers are mostly writing the options.    Its really risky for them to do this so in order to hedge these bets they buy or sell the underlying.   Its called delta hedging.   Delta us how much the option mives w the stock.  The stock is one delta.   The more "in the money" the higher the delta.   Market makers don't care about direction.   They make money on premium and the premium is priced using volatility

When a product has options it gets traded a lot.   But its the same shares being passed back and forth by the same group of market makers.   This is why liquidity increase.   If you need to buy or sell the market maker takes your order.   You don't need to wait for a buyer or seller on other side.

Seems like it would be a net positive for bitcoin. I wonder why there is so much resistance to the idea of bitcoin options. Misinformation maybe?

I dont trade bitcoins but I looked on coinbase and the bid ask spread is $2.  That is crazy wide.   When AAPL was $600 the bid ask spread was still only 10c.

If there were options on bitcoin that increased liquidity the bid ask spread might go down to about 30c. 

The spread is that wide because Coinbase needs to earn a profit and they need to manage risk when buyers are buying from them. The spread on most exchanges is usually much lower but you do need to pay trading fees (~.2% usually - for most customers). If you were to buy AAPL you would still need to pay some kind of commission which would make your "spread" higher.

I don't think that bitcoin has a liquid enough of a market yet to have options and other derivatives based on it's price. Trading volume is high enough so that most people can easily buy or sell the amount of bitcoin they need but is still low when compared to most stocks with similar market caps, and tiny when compared to currencies. ForEX trade volume is measured in the trillions of dollars per day while bitcoin exchange trade is measured in the tens of millions of dollars worth per day.

Options and basic derivatives can reduce volatility on the underlying instrument in general as people who are afraid that the price will go down would not be forced to sell, but instead could purchase put options which would have a lower effect on the market (it would still have some effect as the seller of the put option would need to hedge his risk). When you have derivatives that are complex and that are measured in frequent time periods then they can add to volatility in times of high volatility. One example of this are the ETFs that are designed to get 2x (and 3x) the daily return of the Dow Jones Industrial Average. When volatility was already high the market would have swings in price in the last 30 minutes of trading that would be several time of the swings of prices that occurred for the rest of the trading day. Since these ETFs had to rebalanced their holdings every day so they can get 2x the return of the underlying the following day they were the cause of these huge price swings.

[DrGregMulhauser]

In another thread on here people were talking about hedging bitcoin with derivatives and it made me wonder what sort of effect they would have on bitcoin if we had a robust market for those types of financial instruments.

It's more than a year old now, but in an old article called Bitcoin Derivatives, Liquidity and Counterparty Risk, I suggested that a transparent and robust derivatives market would go a long way toward making BTC a viable currency for larger volume real business use.

Seems like it would be a net positive for bitcoin. I wonder why there is so much resistance to the idea of bitcoin options. Misinformation maybe?

I agree it would be a net positive.

Of course, there was, famously, a BTC vs. USD quasi-options market available for a very long time, but eventually MP backed out of that offering entirely (February, maybe?). Ironically enough, I had warned that MP's approach to market making was a ticking time bomb, and MP publicly ridiculed that warning -- thereby revealing his profound failure to grasp the details of effective hedging along the way. Lo and behold, just a couple of months later, one encounter with a single trader who did grasp the details of effective hedging sent MP scrambling for cover and finally convinced him to abandon the effort altogether.

There's a new options offering being put together by the BitShrub guys, but I haven't caught up with them in months and so can't comment on whether it's going anywhere. The last I knew, there was no mpbot-style market making, so without the involvement of market makers with deep pockets and a better grasp of the territory than MP, I think it will likely be a steep uphill struggle to generate any kind of volume.

[Gargulan]

In another thread on here people were talking about hedging bitcoin with derivatives and it made me wonder what sort of effect they would have on bitcoin if we had a robust market for those types of financial instruments.

It's more than a year old now, but in an old article called Bitcoin Derivatives, Liquidity and Counterparty Risk, I suggested that a transparent and robust derivatives market would go a long way toward making BTC a viable currency for larger volume real business use.

Seems like it would be a net positive for bitcoin. I wonder why there is so much resistance to the idea of bitcoin options. Misinformation maybe?

I agree it would be a net positive.

Of course, there was, famously, a BTC vs. USD quasi-options market available for a very long time, but eventually MP backed out of that offering entirely (February, maybe?). Ironically enough, I had warned that MP's approach to market making was a ticking time bomb, and MP publicly ridiculed that warning -- thereby revealing his profound failure to grasp the details of effective hedging along the way. Lo and behold, just a couple of months later, one encounter with a single trader who did grasp the details of effective hedging sent MP scrambling for cover and finally convinced him to abandon the effort altogether.

There's a new options offering being put together by the BitShrub guys, but I haven't caught up with them in months and so can't comment on whether it's going anywhere. The last I knew, there was no mpbot-style market making, so without the involvement of market makers with deep pockets and a better grasp of the territory than MP, I think it will likely be a steep uphill struggle to generate any kind of volume.

What is your solution for effective hedge for option market making?

[DrGregMulhauser]

What is your solution for effective hedge for option market making?

How to do the job of options market making reasonably well was never in question; what was in question was whether MP could possibly be doing it if he was being truthful with his public claims never to hedge and never to take a naked position. My initial comment about this elicited a cloud of huffing and puffing from the PR lackey and then from MP, to which I later replied.

However, my original point was not to re-hash the well-known weaknesses of MP's approach, but merely to note the historical context that there had been a BTC vs. USD quasi-options market available for a long time, where by "long time" I mean relative to the minuscule amount of time that BTC itself has existed.

[TrailingComet]

Reduce volatility, pretty much every spot market has seen more stability with a functioning well regulated derivatives market

[InwardContour]

Reduce volatility, pretty much every spot market has seen more stability with a functioning well regulated derivatives market

In order for the derivatives market to be functional the spot market would need to be large and liquid enough. IMO bitcoin has not reached that point as of yet.