Bitwise: Why the approval of Bitcoin spot ETF options will lead to a surge in the price of Bitcoin

This Friday, the U.S. SEC approved the listing and trading of options products for BlackRock iShares Bitcoin ETF (IBIT) on the Nasdaq. The trading platform will treat Bitcoin ETF options similarly to other ETF options, subject to the same rules and trading procedures.

Bitwise Alpha Strategy Director Jeff Park published a long article on social media to praise the approval, saying that "this move marks the most significant progress that the cryptocurrency market may have made." He believes that some of the special properties of Bitcoin will be boosted by the rules of the game in the regulated options market. The full text is compiled by BlockBeats as follows:

With the U.S. Securities and Exchange Commission approving the listing and trading of Bitcoin ETF options today, I think we are about to witness the most extraordinary rise in "volatility" in financial history. I think this deserves a more comprehensive explanation, so I want to emphasize some of the characteristics of Bitcoin, the nature of the regulated options market, and the powerful combination of the two. It is no exaggeration to say that this marks the most significant progress that the cryptocurrency market may have made.

For the first time ever. Bitcoin’s notional value will be “partially banked” through ETF options. How can this be explained? While Bitcoin’s non-custodial, capped supply is its greatest strength, it is also a drag, limiting its ability to create synthetic leverage. Despite Deribit’s efforts, it has never adequately solved the counterparty-to-capital efficiency matrix for achieving widespread adoption. And CME futures options require too much active management. Now, for the first time, Bitcoin will have a regulated market, with the OCC protecting clearing members from counterparty risk. This means that synthetic notional exposure to Bitcoin can grow exponentially without incurring JTD risk that has deterred investors. In a liquidity-driven world, unlocking synthetic flows with leverage represents the biggest opportunity for Bitcoin ETFs, which enhances their financial utility compared to spot markets.

In addition, Bitcoin can now use maturity as part of the leverage calculation for the first time. Retail traders have embraced perpetual options for leverage, but these instruments are not perfect and are more akin to a series of daily 0DTE options that must be constantly rolled over. With Bitcoin spot ETF options, investors can now make a portfolio allocation bet based on duration. Especially for the long term. Holding a long OTM call option as a premium outlay has a good chance of giving investors more returns than a fully collateralized position. Bitcoin is often compared to call options because of its decaying premium and occasional explosive upside. Now, investors can bet on "rising volatility" for the same or lower premium while getting more delta over a longer time frame - an attractive opportunity.

Bitcoin also has unique volatility characteristics, one of the most important of which is the “volatility smile”. Most stocks/indices exhibit a “volatility skew” where upside volatility is cheaper than downside volatility (i.e. protection is more expensive than speculation). Bitcoin is unique in that upside moves just as often as downside moves, so the market demands a risk premium on both sides. Historically, for call options, as the spot price rises, implied volatility tends to fall. So while the option delta increases (becoming more ITM), the rate of increase slows – this is positive vanna (dA/dvol), which creates some kind of drag. However, Bitcoin options have negative vanna: as the spot price rises, so does volatility, which means delta increases faster. When traders who are short gamma hedge this (gamma squeeze). The situation for Bitcoin becomes explosively recursive. More upside leads to more upside as traders are forced to keep buying at higher prices. A negative Vanna Gamma squeeze is like a rocket.

BlockBeats Note: Option smiles, also known as volatility smiles, are curves that describe the relationship between option implied volatility and strike price. It is called "volatility smile" because the volatility of out-of-the-money and in-the-money options is higher than that of at-the-money options, making the volatility curve appear as a half-moon shape with a low middle and high sides, like a smiling mouth, so it is called a smiling option.

The most critical factor that ties all of this together is that Bitcoin itself cannot be diluted to accommodate this newfound leverage. Compare it to stocks like GME or AMC. Management can issue new shares to take advantage of pricing anomalies, thereby limiting stock price increases. Bitcoin will never be able to do this. The reader might ask: "But what about commodities like oil or gas? Aren't they analogous? If so, why is Bitcoin different?" The key difference is that most physical commodities have expiration dates, which means they tend to be traded with futures markets rather than spot markets. Unlike spot markets, futures markets have gross and notional exposure that varies based on expiration and net interest in physical vs. paper, so they don't allow for participation focused on one direction (i.e. people are long and short on the curve, and physical vs. paper at the same time). In addition, these markets are subject to supply manipulation by organizations like OPEC.

In summary, the Bitcoin ETF options market is the first time in finance that regulated leverage is available on a truly supply-constrained perpetual commodity. Things could get crazy. In that case, the regulated market would probably shut down.

But what is extraordinary about Bitcoin is that there will always be a parallel, decentralized market that cannot be shut down, unlike GME.

This will be incredibly wonderful.