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The two largest cryptocurrencies by market value, Bitcoin (BTC) and Ethereum (ETH), have been trading unusually steady for over two weeks. The range-bound price movement game likely stems from the market grappling with competing narratives and impacts.
Invisible Hands over the Bitcoin and Ethereum Market
Observers suggest that another power at work, often referred to as the ‘invisible hand’ of crypto options market makers, is partially responsible for keeping prices within a certain range. Market makers are organizations with a contractual obligation to maintain a healthy level of liquidity on an exchange. They ensure sufficient depth in the order book by offering to buy or sell options contracts at any given time.
For instance, if an investor wants to purchase a BTC call option at a strike price of $40,000 and there is no matching sell order, the market maker fulfills the investor’s request by providing a sell order. Options are derivative contracts that grant the buyer the right to buy or sell the underlying asset at a pre-determined price on or before a certain date. While a call option provides the right to buy, a put option provides the right to sell. Therefore, market makers always stand on the opposite side of investors and actively buy and sell the underlying asset in spot or futures markets as price volatility occurs, maintaining a delta-neutral (direction-neutral) order book.
Order Books Filled with “Positive Gamma”
Investors in recent weeks have been occupied with shorting the market against call options or bullish orders, a popular volatility selling strategy aiming to capitalize on spot market assets. Because of this, market makers have filled their order books with long positions or positive gamma. Option gamma reflects the rate of change in the option price in response to volatility in the price of the underlying asset. When gamma is positive, options become more expensive when the price of the underlying asset rises or falls.
A very high positive gamma forces market makers to trade in the exact opposite direction of the movement of spot prices to keep their order books delta neutral. Hence, if Bitcoin and Ethereum prices were to fall, option market makers who have filled their order books with positive gamma would buy cryptocurrencies in the spot market. Similarly, if prices rise, they would sell cryptocurrencies in the spot or futures markets. As a result of this hedging activity, prices remain locked within a narrow range. This is also the reason why Bitcoin and Ethereum prices have recently been stuck within a narrow range.
David Brickell, the institutional sales director at crypto liquidity network Paradigm, commented, “These massive call writing programs have led to dealers being filled with long [positive] gamma. As a result, it turns into a negative feedback loop as hedging gamma risk keeps spot ranges in check by suppressing volatility further, followed by dealers trying to lighten their long gamma positions. Without a catalyst/narrative to start taking directional risk, this systematic, mechanical volatility selling will maintain its weight.”
This event demonstrates the increasing influence of the options market on spot prices, a common feature in stock and forex markets. Crypto investors forced market makers to take short gamma positions by persistently buying call options during the 2021 bull market. This led to market makers being forced to buy BTC and ETH to balance their order books, resulting in exaggerated price movements.
Volatility Could Spike at Any Moment
According to Griffin Ardnern, a volatility trader at a crypto asset management company, the positive gamma in Ethereum, the largest altcoin, has reached a record level, and the sticky effect of market makers’ hedging activity could weaken after monthly options expire. The world’s largest crypto options exchange, Deribit, which controls about 90% of the market, saw the expiry of its May crypto options at 11:00 AM EEST today. This implies that volatility in Bitcoin and Ethereum could increase shortly.
