Bakkt futures recently launched, and the company has announced its intention to roll out options contracts by the end of 2019. The platform came under public scrutiny for abysmal trading volume in the first week. However, it has picked up a significant amount of traction since. With futures start to thrive, and options offering a different variety of benefits, let’s look at what exactly these derivatives bring to the table, and what effect they can have on Bitcoin price.
Options offer the ability to hedge a position with more precision and nuanced risk management. Rather than entering a futures contract based on prevailing conditions and expected future action, an option allows the party conducting the hedge to do so using specific exercise prices.
In developed financial markets, options tend to drastically outweigh futures in trading volume. This essentially boils down to two key factors: price appreciation potential and risk management. Options are favored over futures because positions can be set up in a very effective manner to either mitigate large chunks of the risk for a small yield or taking on a lot of risk in the hope of massive price appreciation.
With Bitcoin, we have had a robust futures market thus far. On platforms like Deribit, options haven’t been a huge hit, mostly because retail investors are simple speculators who aren’t interested in complex financial instruments – yet.
In the future, it would not be a stretch to expect Bakkt options to play a significant role in price discovery. Let me explain why.
Bitcoin miners across the world earn their revenue in BTC and are highly dependent on the Bitcoin price. So in order to hedge this dependence they have on bitcoin price, they enter short positions on futures contracts to sell their BTC at a fixed price, no matter what happens in the spot market. The introduction of options brings a fresh paradigm whereby investors can execute more dynamic hedges that allow them to keep the upside potential that comes with BTC without taking much downside risk.
Options are incredibly efficient when it comes to execution strategies, but they are quite complex, making them slightly out of reach for the regular retail investor.
Many institutional investment managers prefer to wind down their positions throughput options (buying the right to sell an asset at a prescribed price) rather than only the spot market.
This tends to have a positive impact on price because less supply is pushed onto the spot market, hence reducing downside potential. For larger investors, this makes a lot of sense and helps them secure a strong price.
In the long run, I believe Bakkt will have a great influence on the Bitcoin price. Futures may naturally adjust spot prices down when there are many short positions, but options will mask a lot of sentiment, that ultimately shows up in the spot market later.
Effectively, miners who enter these positions are dependent on bitcoin price for appreciation/depreciation of their revenue. Options will help them unwind this without creating a massive sell-off and crashing prices.
I see Bakkt options as a net positive for Bitcoin price stability and network adoptions from larger players.