This year has been a very exciting year for cryptocurrency investors. First, with the approval of the well-rumored Bitcoin ETFs in January, the mainstream era of Bitcoin investing finally came to be. January was the catalyst for this followed by another halving event in April. Thus, bitcoin has had two big catalysts go in its favor. This has led to a move from $40K to the current $58K, a good year by all estimations. However, bitcoin is also well-off its highs for the year, as it touched close to $75K back in March before the halving. Thus, for those that went long for the halving catalyst, an event that had never seen the price go lower over a three-, six- or 12- month basis, are underwater. In fact, there have been some estimations that the average price accounts are long Bitcoin ETFs from is about $60K, suggesting the money that has flowed into the ETFs might also be underwater. Have these catalysts been what was expected? Were they so well-rumored that it was a buy-the-rumor and sell-the-news event? Now, traders and investors are beginning to speculate if ether will get the same bump in price as ETF listings are approved for Ether products. Some see a bump in price the same way bitcoin moved. The top chart shows the overlay of generic front month futures in both bitcoin and ether, with bitcoin leading by four months, trying to anticipate what a move in ether could look like. However, the bottom chart shows the two products with no lead/lag and we can see that both have moved in lockstep even though the catalysts this year have been almost entirely in bitcoin and not in ether. 

Even though the futures have moved in lockstep from a 10,000 foot perspective, there has been a tradable spread between them. This tradable spread is beginning to look potentially stretched. The top chart looks at the absolute spread between generic front month bitcoin and ether, and shows that ether appears to have lagged quite considerably. In fact, if we look at this price performance from the beginning of 2022 until the present, the current ether price is almost 1.5 standard deviations cheap relative to the long-term mean. 

Looking at the price in absolute terms may not be the right way to look at it, however. After all, bitcoin price is considerably higher, so a trader looking to trade this spread would want to do it with some multiple so that the dollar amount of each position is the same. This is a little difficult to do over time, but if I approximate this multiple as 15x, since that multiple appeared to hold pretty well for all of 2022 and half of 2023, we can see that the spread has still widened and may not be 1.5 standard deviations wide, but is still more than 1.3 standard deviations wide. Either way we look at it, one can make the argument that the price of ether has lagged the price of bitcoin on a spread basis. 

Another way to look at this relationship is to look at a chart of the relative prices, dividing one price by the other. Here, I look at what a position of long ether and short bitcoin would look like on the charts. One can see that since September of 2022, the price of ether has consistently lagged the price of bitcoin, and a trader who was in this position has seen a series of lower highs in the relationship. The place where the relative price just bottomed goes back to early 2021, and looking at this relationship, one can see that a descending triangle pattern is developing. The good news is that at the current relationship of 0.054, the relative price is testing that upper band and could move higher. If we think of this as a multiplier, that 0.054 is about 18x. A return to the 15x relationship from 2022 would put the relative price at 0.07. A move to 0.05 would be 20x and back to 0.04 would be 25x. A move back to the relative highs for ether is 12.5x. This is just another way to think of it (i.e., if I put on this spread at 18x, and it moves to 15x, I am net long 3x ether).

Of course, this relationship can change whether both futures move higher, move lower and move apart while in a range. In fact, the relative highs for ether in 2022 were during the crypto winter. While it is too early to say that ether does better on the downside, we do have an example of where it has done so. It is conceivable this relative price could also move higher in both futures. The trader of this spread may be agnostic of the direction of crypto overall, only caring about the relative price as they are or can be dollar neutral. 

Looking at the daily ichimoku charts for both Bitcoin and Ether, it looks like two assets that have broken down and then recovered, but are only back at resistance at this time. Both futures moved below the daily ichimoku cloud, which can be interpreted as the level at which buyers and sellers are indifferent. Thus, a move below the cloud means the bears are in control of the tape and the bulls are underwater. The MACD recovered and has pointed higher but markets are running into cloud resistance on both the price and the lagging span. Thus, the bulls have made a valiant effort in both assets, but until price breaks above the cloud, and ideally the cloud price starts to turn higher itself, it is likely that markets are in for an extended period of consolidation at this point.

With the two major bitcoin catalysts in the rear view mirror, I tried to find what could potentially be the next catalyst. Of course, an Ether ETF could be a catalyst, but as we saw with the Bitcoin ETF, this could be a case of buy-the-rumor and sell-the-news.  There may be another catalyst that has quietly gone by that has the potential to have a more lasting impact. In March of this year, ether went through the Dencun Upgrade, a hard fork on the chain, which included nine improvements designed to supercharge network scalability, reduce transaction fees and boost security. This, combined with the previous ether upgrade in a move to proof of stake vs. proof of work, are intended to see the ethereum network used for more transactions than the bitcoin network. As the chain is the one that allows for smart contracts and self-executed code, in a world of artificial intelligence, one can potentially envision how the ethereum network has more use cases going forward.

The way I try to determine if the Dencum Upgrade was successful or not is by looking at the chart of the transaction costs also known as gas fees. I show the year-to-date costs for gas on the ethereum network and it is clear that since the upgrade fees have dropped considerably from a number that exceeded 50 Gwei to the current 4.677 Gwei. This is a material reduction in costs, which has led to a high adoption rate for Level 2 applications on the ethereum network, precisely what was intended. This has bullish implications for the usage of the network on a go-forward basis. 

The next step in developing this trade idea is to look at the term structure of implied volatility. The chart of bitcoin implied volatility is in the top chart with ether implied volatility in the bottom chart. You can see that at every expiration, ether trades at a premium of about 10-12 volatility points. This leads me to try to find a way where I am selling Ether options to buy Bitcoin options if at all possible. If I am looking at a relatively bullish ether vs. bitcoin price pattern, this leads me to consider the possibility of selling ether puts to buy bitcoin puts.

Next I take a look at the open interest and volume for Bitcoin and Ether options. The clear takeaway for me in these two charts is the put/call relative volume. In the top chart, one can see that the relative volume of puts vs. calls in bitcoin has put in a series of lower highs, suggesting perhaps a waning demand for puts. The bottom chart of Ether options shows a very different pattern, as the relative demand for puts vs. calls is at the highs for the year. Are traders more nervous about hedging ether positions? Are traders worried about a sell-the-news price action if Ether ETFs are approved? Either way, we can see there is more demand for ether puts on a relative basis.

When deciding how and where to implement this idea, I want to consider a couple of different things. First, I want to consider the expiration I would use. Second, I want to consider which delta options to use. For the first, I want to look at August options, as I feel that the next month or so will be critical for markets of all kinds as the political season really kicks off in the U.S., liquidity dries up with participants on vacation and catalysts in many assets picking up.  Looking at the August options for each expiration, I can see that implied volatility is pretty flat between 30 delta puts, 30 delta calls and the at-the-money options. This lack of skew and kurtosis is somewhat interesting and potentially indicative of a maturing asset class, which should not be surprising given the growing institutional adoption. I want to consider the 30 delta puts in each product as the sweet spot for this spread.

Finally, we come to the implementation. I have looked at approximately 30 delta puts in August for both bitcoin and ether. I can see that in bitcoin this is the 55000 puts and for ether this is the 3000 put. I can see that the implied volatility for the bitcoin puts is just under 49, while the implied volatility for ether puts is just over 61. This 12 point implied volatility premium is one of the wider spreads I see for the same delta options.  I also see that the premium differential (2451 for bitcoin and 153.62 for ether) is a ratio that is a bit more than 18x. Thus, the trader has a couple different ways that they can potentially look to implement this idea.

First, if the trader is bearish on cryptocurrency overall and thinks the prices for both futures can trade lower with the recent technical breakdown, but that bitcoin will fall faster than ether in a repeat of the 2022 price action, the trader might consider doing this spread on a one for one basis, long one Bitcoin option and short one Ether option. While this would mean a premium outlay, the trader may want to be long option convexity overall and just use the Ether options as a way to slightly reduce the cost of the Bitcoin options. If the relative price for ether moves higher, while both prices move lower, this will mean Bitcoin futures will end up much more below strike – netting a bigger gain. The risk is that futures prices go nowhere or move higher and there is a loss of premium.

Second, the trader may look at the current 18x relationship and choose to put this trade in on a dollar neutral basis, selling ether puts and buying bitcoin puts. If futures prices move higher or stay the same, finishing above strike in each case since it is done in a dollar neutral way, there is no money lost. If futures prices both move lower, then it is incumbent on Ether options faring relatively better with the relationship returning to about 15x. For example, if I buy one Bitcoin 55000 put and sell 18 Ether 2900 puts, and the price of bitcoin moves to 45,000 but the relationship returns to 15x, the price of ether would be 3000. Thus, Bitcoin options would be in the money while the Ether options would be out of the money for a net gain. The risk to the trader is that the prices both move lower, and the relationship stays the same or moves wider.

On a relative option trade with two different underlying prices, there are admittedly many moving parts for the idea. However, in highly correlated assets with relationships that have moved away from their long-term mean, this type of statistical arbitrage has been something occurring in markets for decades. Layer in the existence (or lack) of catalysts, there is the possibility of some interesting relative trades that may more uniquely fit the traders’ views. With CME Group and QuikStrike, a trader has the tools to put these ideas together and to execute.

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