The leading two cryptocurrencies by market value, bitcoin (BTC) and ether (ETH) have been unusually quiet for more than two weeks. The market’s encounter with opposing narratives and influencers is likely what led to the range play.
Observers claim that a second strong force, the so-called “invisible hand” of crypto options market makers, is also at work and is partially to blame for the stability of price ranges. Market makers are companies that have a legal obligation to keep an exchange’s liquidity at a healthy level. By indicating their willingness to purchase or sell a call or put option contract at any time, they guarantee that the order book has enough depth.
If we set an example of a trader who wishes to purchase a BTC call option with a $40,000 strike price but there isn’t a corresponding sell order, the market maker would fill the gap by supplying the sell order. Options are derivative contracts that grant the buyer the option to buy or sell the underlying asset at a defined price on or before a given date. The right to buy is provided by a call option, whilst the right to sell is provided by a put option.
Market makers regularly purchase and sell the underlying asset in the spot or futures market as the price fluctuates in order to maintain a delta-neutral (direction-neutral) book and to always be on the other side of investors.
Investors have recently been shorting or writing call options or bullish bets, a common volatility-selling technique meant to produce a yield in addition to holdings on the spot market. Market makers are now overloaded with long call positions or positive gamma as a result. The rate at which the price of an option fluctuates in reaction to changes in the price of the underlying asset is known as the options gamma. When gamma is positive, options are more expensive whether the price of the underlying asset increases or decreases.
Large positive gamma forces market makers to trade against the direction of the current price movement in order to maintain delta neutrality in their books. Therefore, the options market makers, loaded with positive gamma, must purchase cryptocurrencies on the spot market if Bitcoin and ether decline. In the event that the market rallies, they must place bearish bets in the spot and futures markets. Prices have been held steady in the constrained range as a result of this hedging action.
The dealers are packed long [positive] gamma as a result of these enormous call overwriting activities. As a result, gamma hedging limits spot ranges, increasing volatility, and dealers aim to reduce long gamma positions, according to David Brickell, director of institutional sales at cryptocurrency liquidity network Paradigm.
“That systematic, mechanical volatility selling will keep weighing,” Brickell continued, “in the absence of a catalyst/narrative to start taking a directional risk.”
The instance demonstrates the options market’s expanding impact on spot pricing, a characteristic of the equity and foreign exchange markets generally. Throughout the bull market of 2021, crypto investors consistently purchased call options, leaving market makers with short gamma holdings. Because of this, market makers had to trade in favor of Bitcoin and ether in order to balance their books, which led to inflated price movements.
The positive gamma in ether has reached a record high, according to volatility trader Griffin Ardnern from a crypto asset management company, and the sticky effect of market makers’ hedging activities may lessen after the monthly options expiry. Deribit will settle May expiry options on Friday at 08:00 UTC. Deribit is the largest cryptocurrency options exchange in the world and has approximately 90% of the market.
Market makers tend to sell high and buy low when hedging against positive gamma, compressing the price movement range to be close to the strike price, according to Ardern, speaking to CoinDesk. “After the settlement, there will be a significant reduction in the sticky effect of hedging on the price, but there may be more resistance, especially in ETH. The potential for a decline in the price of ETH must be taken into consideration.
Market makers have significant positive gamma in the higher strike price ether options expiring in the upcoming months, according to Ardern, and this would act as resistance.
“Market makers will contemplate selling spots or perps to hedge the delta that may go over the limit if the price of ether swings [higher] and near these levels, as this will raise the delta in their possession. According to Ardern, “This selling behavior generates quite significant opposition.