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Bitcoin (BTC) and ether (ETH), the two leading cryptocurrencies in terms of market value, have experienced an unusually tranquil period lasting for more than two weeks. This state of relative stability is likely a result of conflicting narratives and influences that have impacted the market.
There exists an additional influential factor in play, commonly referred to as the hidden influence of crypto options market makers, which is partially accountable for maintaining prices within a specific range, as per observers.
Market makers are responsible for ensuring sufficient liquidity on an exchange through contractual agreements. They play a crucial role in maintaining a healthy trading environment by consistently offering to buy or sell call/put option contracts, thereby adding depth to the order book and facilitating smooth transactions at any given moment.
For example, when a trader intends to purchase a BTC call option with a strike price of $40,000 but no corresponding sell order is available, the market maker takes the necessary action by providing the sell order. Options are contracts derived from underlying assets, granting the buyer the privilege to either buy or sell the asset at a predetermined price before a specified date. A call option bestows the right to purchase, whereas a put option grants the right to sell.
Market makers, in turn, consistently stand against investors and uphold a delta-neutral (direction-neutral) portfolio by actively engaging in buying and selling the underlying asset in the spot or futures market, adapting to price fluctuations.
Stuffed with "positive gamma"
In the past few weeks, investors have actively engaged in shorting or selling call options as part of a popular strategy to profit from volatility and generate additional returns alongside their spot market holdings. Consequently, market makers have accumulated significant long call positions or positive gamma. Options gamma refers to the rate at which the price of options changes in response to fluctuations in the underlying asset's price. When gamma is positive, options tend to become more expensive as the price of the underlying asset rises or falls.
Maintaining substantial positive gamma positions compels market makers to trade in the opposite direction of spot price movements in order to maintain a delta-neutral portfolio. Consequently, when the prices of Bitcoin and Ether decrease, options market makers, who hold significant positive gamma exposure, are required to purchase cryptocurrencies in the spot market. Similarly, during market rallies, they must engage in bearish trades in spot and futures markets. This hedging activity has contributed to price consolidation within a narrow range.
"These massive call overwriting programs have left dealers stuffed long [positive] gamma. So it becomes a negative feedback loop as the gamma hedging keeps spot ranges contained, weighing further on volatility, then dealers also try to lighten on long gamma positions," David Brickell, director of institutional sales at crypto liquidity network Paradigm, said.
"In the absence of a catalyst/narrative to start taking a directional risk, that systematic, mechanical volatility selling will keep weighing," Brickell added.
The episode highlights the increasing impact of the options market on spot prices, a phenomenon commonly observed in equity and foreign exchange markets. Throughout the bullish market of 2021, crypto investors consistently purchased call options, leaving market makers with short gamma positions. This compelled market makers to engage in trading activities aligned with the movements of bitcoin and ether in order to manage their portfolios effectively, consequently leading to amplified price fluctuations.
Griffin Ardnern, a volatility trader at a leading crypto asset management firm, has reported a historic surge in positive gamma for ether. This implies that the influence of market makers' hedging actions may undergo a weakening effect following the expiration of monthly options. Notably, Deribit, the world's largest crypto options exchange, which commands nearly 90% of the market share, is set to settle the May expiry options on Friday at 08:00 UTC.
"In the case of positive gamma, the delta hedging behavior of market makers is to sell high and buy low, which compresses the price movement range to near the strike price," Ardern told CoinDesk. "After the settlement, the sticky effect of hedging on the price will significantly weaken, but there could be stronger resistance, particularly in ETH. It is necessary to be careful about the risk of ETH price going downwards."
Market makers currently maintain a significant amount of positive gamma in the higher strike price ether options expiring in the upcoming months, which is expected to generate a substantial level of resistance.
"If ether's price moves [higher] and approaches these levels, the delta in the hands of market makers will increase, and they will consider selling spots or perps to hedge the delta that may exceed the limit. This selling behavior creates relatively significant resistance," Ardern added.
From May 12 onwards, bitcoin has maintained a tight trading range of $25,800 to $27,600, while ether has consolidated within the range of $1,750 to $1,850. As of the current moment, based on CoinCryptoUs data, bitcoin is being traded at $26,350, while ether is valued at $1,800.
