Crypto Volatility in Review: September 2023

Relative Vol Levels

The volatility of both majors largely arrested its downwards slide in September, with BTC and ETH options struck at-the-money (ATM) trading in the same 35%-50% range as at the beginning of the month. Implied vols began to move sideways in mid-August, soon after a spike caused by spot prices falling back to $26.5K and $1.6K respectively – levels that they traded close to for the rest of September.

Delayed spot ETF decision dates, strong Binance and Huobi FUD, and acceptance of the “higher-for longer” rates message have done little to return volatility expectations to the highs to which we have become accustomed. While each of these factors has had the potential to dominate narratives, no one sentiment has won out as attention now shifts to the trial of FTX founder SBF. One narrative that we remain interested in is the rise of BTC’s implied volatility relative to ETH’s. The ratio between the two assets continued to lean in favour of higher BTC vols than ETH’s in September, continuing the near-monotonic trend that began more than a year ago falling the selloff in volatility after its execution layer was successfully merged into the Beacon chain.

Somewhat strangely, the same trend in realised volatility appears to have “bounced” off the parity line. This has followed the convergence of the volatility delivered by both assets to similar values. As we will see in the subsequent section, their realised volatilities have converged as both hurtle towards historical lows.

Volatility Premia

The myriad competing narratives have also failed to support the realised volatility of either asset, which fell to fresh all-time lows for ETH in September. Similarly, the spot price of Bitcoin has not moved with this little volatility since Nov 2018, the depths of a previous crypto-winter. Despite delivering lower volatility, both assets’ implied volatility levels have drifted upwards slightly from their August lows.

Beginning at the turn of the month and persisting throughout, the implied volatility of both majors also began to rise relative to the continued cascade of realised volatility, despite remaining relatively range bound in absolute terms. As a result, the ratio of implied-to-realised volatility has trended significantly above 1. Bitcoin options have demanded a larger volatility premium since mid-June, with the premium assigned to ETH optionality lagging behind somewhat. Previously, the ratio of each asset had moved closely with one another from early March.

Compared to their historical distributions (daily from 1st January 2020), the latest values of BTC’s and ETH’s implied-to-realised volatility ratios reflect a relatively high pricing of volatility. The ratio of BTC options has spent only 27% of its time above the current value of 1.21. ETH’s markets have priced for a higher volatility premium than 1.16, their current value, just 22% of the time.

We also note that BTC derivatives markets have tended to assign a higher premium to volatility than ETH’s. In this context, the current dominance of BTC’s premium over ETH’s is not unusual, although the dominance of its outright level of volatility is. While ETH’s outright volatility (both realised and implied) has fallen below the level of BTC’s in recent months, the pricing of its forward-looking volatility expectations relative to its recent behaviour is inline with historical performance.

The Smiles Remain Steep

The historically high steepness in the volatility smiles of both majors has continued into a third month. First noting this phenomenon in July, we observed the SABR volatility of volatility parameter (which controls the curvature – and thus the steepness – of the volatility smile) grow to historically high levels for ETH. Having lagged the growth in ETH’s somewhat in August, the steepness of BTC’s 1M constant tenor smile caught up to ETH’s to reflect a similarly high pricing of volatility in the wings relative to their ATM levels.

As it was in both previous months, this phenomenon is most extreme at a 1 month tenor, with both BTC and ETH smiles nearest to the top end of their historical distributions at this point on the term structure. September’s steepening in BTC’s smile brings the calibrations of both assets back in line with each other, with both markets reporting a similar relative demand for OTM optionality.

An Uncertain Outlook

September saw the continuation of two trends: first, we continue to see OTM optionality priced near to its highest levels relative to the ATM level of implied volatility as the volatility smiles of both assets remain near to their historically steepest levels. Second, ETH’s implied volatility is still below the levels priced by BTC’s derivatives markets having continued the trend that it began following The Merge in September last year. However, a similar trend in the ratio of their realised volatility appears to have settled, with the ratio trading sideways near to 1 since the middle of 2023.

BTC’s and ETH’s realised vol levels have converged towards each other at the same time as reaching historically low levels. As outright implied vol levels have remained within their range, the volatility premium priced by both markets is now at elevated levels as competing narratives add to uncertainty.