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Surviving Crypto Volatility With Derivatives Contracts

Surviving Crypto Volatility With Derivatives Contracts

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Different forms of derivatives trading could become the next step toward crypto mass adoption and give investors more transparency.

Volatility has been the dominant theme in financial markets lately. As uncertainty around COVID-19 and its impact on the economy deepens, markets have been swinging wildly. We’ve seen the S&P 500 falling off a cliff as well as risk assets across the board taking a beating. Cryptocurrency markets have been no different and have exhibited extreme volatility. Amid the pessimism, Bitcoin (BTC) broke below the $4,000 mark on Black Thursday and fell nearly 50% from recent highs. 

It’s been over a month since the crash, and though we have seen prices bouncing back sharply, the sentiment has not improved. There is still a fair amount of fear among traders, and they continue to stay hawkish. Such sharp moves hurt market confidence, and it will take some time before traders get comfortable carrying overnight risk again.

It is hard to say how long it will take for the markets to recover and for the true impact of the current crisis to be visible. Some estimates suggest that it will take as long as 12–18 months for the world economy and markets to fully overcome this shock. Given the backdrop, it’s fair to say that markets should remain choppy for some time and that the volatility is here to stay.

Volatile markets increase directional risk

Extreme volatility in the markets spells trouble for traders caught on the wrong side of price swings. On March 12, the price of Bitcoin dropped by over 40% and subsequently recovered 16% the next day. Over $750 million worth of positions went into liquidation amid these swings. 

Bitcoin volatility spiked to 250% per annum in March, and though it has cooled down to about 70%, it still remains quite rich. Carrying directional trades in such volatile market conditions is very risky. In fact, the higher the volatility, the higher the directional risk for traders. If traders don’t maintain enough margin in their positions, there is a chance of getting caught on a price whipsaw and getting liquidated. Violent price swings have been a regular feature since Black Thursday. This has made directional trading difficult not only for new traders but also for veterans. 

Isolating directional risk from volatility risk 

In calm market conditions, traders look to profit by catching the momentum of the market direction. If they predict the market direction correctly, they register a profit. Similarly, if the market moves against them, there will be losses. The amount by which a trader’s portfolio is going to get impacted per unit movement in price is called “delta” — a measure of directional risk. There is another risk to a trader’s portfolio, something that most traders tend to ignore during calm market conditions: the risk of price swinging up and down while it drifts in a particular direction. This risk to a trader’s portfolio is called “vega” and measures the risk against change in volatility.

Just as traders use futures contracts to position themselves for directional risk, options are useful for protecting against rising or falling market volatility. Traders can also use options to remove directional risk from their portfolios, partially or completely, and bet on market volatility alone. 

Some exchanges are at the forefront of innovation here and are offering products that allow traders to trade the volatility risk without taking any directional risk. Hence, should a trader believe that the market is going to stay volatile, they can buy volatility without exposing themselves to the effects of which direction the market moves in.

Growth in crypto options segment

As crypto derivatives markets mature, we are seeing more and more traders participate in options markets and trading volatility. In traditional markets such as equities, the volumes on options contracts can be multifold of those on futures contracts. Though crypto options markets have existed for a few years now, the volumes have been slow to pick up. 

Most crypto traders find options trading difficult to understand and intimidating. There is a need to package options in a way so that traders can easily understand the payoff profile without diving into the nitty-gritty. This would help reduce the friction and increase the demand for crypto options trading. A MOVE contract is one such product. Herein, a trader holds a straddle: a multilegged options position that will benefit from higher market volatility irrespective of market direction. 

The straddle strategy, simplified

One of the ways to own volatility is to buy a straddle. A straddle is nothing but a call and a put option combined together. Hence, one can create a long straddle position by buying a call option and a put option that have the same strike price and maturity. If the market rises, the call option becomes profitable; should the market fall, the put option starts to payoff. Building a straddle position by oneself can be complex for traders. Not only do they need to find liquidity in both the call and put options, but they must also execute both the legs of the trade simultaneously. 

MOVE contracts are nothing but a packaged straddle position. Thus, when a trader is buying a MOVE contract, they are essentially buying a call and a put option with the same strike and in equal amount. 

The crypto equivalent of trading the VIX

Cboe has an index called the Volatility Index, or VIX, which is also known as the fear index. The reason the VIX is called a fear index is because its value rises when market uncertainty or fear is high and falls when the market is calm. Investors can’t directly invest in the VIX, but they can bet on the VIX going up or down by trading futures on the VIX or by purchasing VIX-related products such as VIX futures exchange-traded funds. In cryptocurrency markets, trading MOVE contracts is the equivalent of trading VIX products, as it gives investors pure exposure to the volatility of crypto.

Removing settlement currency risk

Another important aspect of any derivatives product is the settlement currency — i.e., the currency in which the final profit or loss is realized. The default settlement currency for most crypto derivatives products is Bitcoin. This is understandable, given that when the crypto derivatives ecosystem was starting, stablecoins were still not commonplace. Thus, products that allowed payoff in Bitcoin or other cryptos were innovated. This was also partly driven by customer demand, as traders focused on increasing their count of Bitcoin. Things have changed a lot in the last 12 months, and we’ve seen a strong demand for stablecoin settlement in the crypto derivatives segment. 

Gold futures, stablecoin futures and the growing demand for stable assets

Other ways to combat a volatile market include switching to low-risk assets such as gold.  Futures contracts on gold-backed coins have provided crypto traders with a way to protect their portfolio value in times of widespread uncertainty. These derivatives have also opened a new sector of trading that allows crypto traders access to physical gold. They have been in high demand on many derivatives exchanges because of the recent gold price spike in the backdrop of the coronavirus scare and global markets sell-off.

Futures contracts on stablecoins are also getting popular, as there are arbitrage opportunities for traders to earn profit in a stable token’s value while taking minimal risk. Overall, the industry has seen a surging demand for a stable digital currency amid fears of an economic recession and will continue to rely on stablecoins as a safe haven.

Final thoughts

Derivatives provide a way for traders to hedge in times of high market uncertainty, isolate and protect against different kinds of risks, and aid in true price discovery. In the long run, a healthy derivatives market helps to reduce the long-term volatility of an asset class.

The crypto derivatives segment has seen huge growth in the last two years, but we’ve only scratched the surface as of yet. For mature asset classes, derivatives markets are four to five times the size of spot markets. Currently, Bitcoin perpetual swaps make for the lion’s share of the crypto derivatives segment. As crypto derivatives markets grow, we will see increased demand to trade futures on other coins beyond Bitcoin and for options, as they provide a way for traders to manage volatility risk.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, you should conduct your own research when making a decision.

Pankaj Balani is the CEO and founder of Delta Exchange. With over eight years of experience as a business leader and derivatives trader, Pankaj has dedicated the last two years to building Delta Exchange, a next-generation derivatives exchange where traditional financial instruments and cryptocurrency trading intersect. Pankaj has extensive experience in quantitative finance, derivatives and global capital markets through his positions at UBS Investment Bank, Edelweiss Asset Management and Elara Capital. He also led product and growth for Purplle.com, an e-commerce business that was recently funded by Goldman Sachs. He graduated from the Indian Institute of Technology in Delhi with a degree in engineering physics and obtained a master of business administration from the Indian School of Business.

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$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

A new report published by the Employment Research…

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$265 Billion In Added Value To Evaporate From Germany Economy Amid Energy Crisis, Study Warns

A new report published by the Employment Research (IAB) on Tuesday outlines how Germany's economy will lose a whopping 260 billion euros ($265 billion) in added value by the end of the decade due to high energy prices sparked by Russia's invasion of Ukraine which will have severe ramifications on the labor market, according to Reuters

IAB said Germany's price-adjusted GDP could be 1.7% lower in 2023, with approximately 240,000 job losses, adding labor market turmoil could last through 2026. It expects the labor market will begin rehealing by 2030 with 60,000 job additions.

The report pointed out the hospitality industry will be one of the biggest losers in the coming downturn that the coronavirus pandemic has already hit. Consumers who have seen their purchasing power collapse due to negative real wage growth as the highest inflation in decades runs rampant through the economy will reduce spending. 

IAB said energy-intensive industries, such as chemical and metal industries, will be significantly affected by soaring power prices. 

In one scenario, IAB said if energy prices, already up 160%, were to double again, Germany's economic output would crater by nearly 4% than it would have without energy supply disruptions from Russia. Under this assumption, 660,000 fewer people would be employed after three years and still 60,000 fewer in 2030. 

This week alone, German power prices hit record highs as a heat wave increased demand, putting pressure on energy supplies ahead of winter. 

Rising power costs are putting German households in economic misery as economic sentiment across the euro-area economy tumbled to a new record low. What happens in Germany tends to spread to the rest of the EU. 

There are concerns that a sharp weakening of growth in Germany could trigger stagflation as German inflation unexpectedly re-accelerated in July, with EU-Harmonized CPI rising 8.5% YoY. 

Germany is facing an unprecedented energy crisis as Russian natural gas cuts via the Nord Stream 1 pipeline will reverse the prosperity many have been accustomed to as the largest economy in Europe. 

"We are facing the biggest crisis the country has ever had. We have to be honest and say: First of all, we will lose the prosperity that we have had for years," Rainer Dulger, head of the Confederation of German Employers' Associations, warned last month. 

Besides Dulger, Economy Minister Robert Habeck warned of a "catastrophic winter" ahead over Russian NatGas cut fears.

Other officials and experts forecast bankruptcies, inflation, and energy rationing this winter that could unleash a tsunami of shockwaves across the German economy.  

Yasmin Fahimi, the head of the German Federation of Trade Unions, warned last month:

"Because of the NatGas bottlenecks, entire industries are in danger of permanently collapsing: aluminum, glass, the chemical industry." 

IAB's report appears to be on point as the German economy seems to be diving head first into an economic crisis. Much of this could've been prevented, but Europe and the US have been so adamant about slapping Russia with sanctions that have embarrassingly backfired. 

Tyler Durden Wed, 08/10/2022 - 04:15

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International

“Anything But A Cashless Society”: Physical Money Makes Comeback As UK Households Battle Inflation

"Anything But A Cashless Society": Physical Money Makes Comeback As UK Households Battle Inflation

The World Economic Forum (WEF) has been…

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"Anything But A Cashless Society": Physical Money Makes Comeback As UK Households Battle Inflation

The World Economic Forum (WEF) has been pushing hard for a 'cashless society' in a post-pandemic world, though physical money has made a comeback in at least one European country as consumers increasingly use notes and coins to help them balance household budgets amid an inflationary storm

Britain's Post Office released a report Monday that revealed even though the recent accelerated use of cards and digital payments on smartphones, demand for cash surged this summer, according to The Guardian. It said branches handled £801mln in personal cash withdrawals in July, an increase of 8% over June. The yearly change on last month's figures was up 20% versus the July 2021 figure of £665mln.

Across the Post Office's 11,500 branches, £3.31bln in cash was deposited and withdrawn in July -- a record high for any month dating back over three centuries of operations. 

The report pointed out that increasing physical cash demand was primarily due to more people managing their budgets via notes and coins on a "day-by-day basis." It said some withdrawals were from vacationers needing cash for "staycations" in the UK. About 600,000 cash payouts totaling £90mln were from people who received power bill support from the government, the Post Office noted. 

Britain is "anything but a cashless society," according to the Post Office's banking director Martin Kearsley.

"We're seeing more and more people increasingly reliant on cash as the tried and tested way to manage a budget. Whether that's for a staycation in the UK or if it's to help prepare for financial pressures expected in the autumn, cash access in every community is critical," Kearsley said.

We noted in February 2021, UK's largest ATM network saw plummeting demand as consumers reduced cash usage. At the time, we asked this question: "How long will the desire for good old-fashioned bank notes last?

... and the answer is not long per the Post Office's new report as The Guardian explains: "inflation going up and many bills expected to rise further – has led a growing numbers of people to turn once again to cash to help them plan their spending." 

So much for WEF, central banks, and major corporations pushing for cashless societies worldwide, more importantly, trying to usher in a hyper-centralized CBDC dystopia. With physical cash back in style in the UK, the move towards a cashless society could be a much more challenging task for elites than previously thought. 

Tyler Durden Wed, 08/10/2022 - 02:45

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International

Something Just Doesn’t Add Up In Chinese Trade Data

Something Just Doesn’t Add Up In Chinese Trade Data

By Ye Xie, Bloomberg markets live commentator and reporter

An unusual discrepancy has…

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Something Just Doesn’t Add Up In Chinese Trade Data

By Ye Xie, Bloomberg markets live commentator and reporter

An unusual discrepancy has showed up in two sets of trade data in China. Depending on which official sources you use, China’s trade surplus, could either be overstated or under-reported by a staggering $166 billion over the past year.

China watchers cannot fully explain the mystery. It’s as if Chinese residents bought a lot of stuff overseas, and instead of shipping the items home, they were kept abroad for some reason.  

China’s exports have been surprisingly resilient, despite a slowing global economy and Covid disruptions. On Monday, General Administration of Customs data showed China’s exports increased 18% in July from a year earlier. In contrast, imports grew only 2.3%, reflecting weak domestic demand.

The result is China’s trade surplus keeps swelling, which has underpinned the yuan by offsetting capital outflows. The surplus over the past year amounted to a record $864 billion, more than double the level at the end of 2019.

But when comparing the Customs data with that from the State Administration of Foreign Exchange (SAFE), a different picture emerges. The SAFE data shows the surplus is growing at a much slower pace -- about 20% less than the customs figure

The two data sets used to track each other closely. SAFE typically reports fewer imports, thus a higher surplus, because it excludes costs, insurance and freight from the value of goods imported, in line with the international standard practice, Adam Wolfe, an economist at Absolute Strategy Research, noted.

The other adjustments that SAFE does include:

  • It only records transactions that involve a change of ownership;
  • It adjusts for returned items;
  • It adds goods bought and resold abroad that don’t cross China’s border, but result in income for a Chinese entity -- a practice known  as “merchanting.”

The relationship between the two data sets has flipped since 2021, as SAFE reported higher imports, resulting in a smaller surplus than the Customs data.

It’s particularly odd because it happened at a time when shipping costs skyrocketed. When SAFE removes freight and insurance costs, it would have resulted in even lower, not higher, imports.

Taken at face value, the discrepancy suggests that somebody in China “bought” lots of goods from abroad, but they have never arrived in China. These transactions would be recorded by SAFE as imports, but not at the Customs office.

Craig Botham at Pantheon Macroeconomics, suspects that Covid-19 may be playing a role here. Foreign firms unable to manufacture in factories elsewhere during the pandemic might have transferred materials to China for assembly, a transaction excluded by SAFE.

Could Chinese buyers overstate their foreign purchases to SAFE, which regulates the capital account, so they can move money out of the country? The cross-border transactions show there was widespread overpaying for imports in 2014-2015, during a period of intense capital flight, but not at the moment, Wolfe pointed out.

Source: Absolute Strategy Research

The bottom line is that there aren’t many good explanations. As Alex Etra, a senior strategist at Exante Data, said, there’s “no smoking gun” to suggest something fishy is going on.

It’s another mysterious puzzle waiting to be solved.

Tyler Durden Tue, 08/09/2022 - 22:28

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