This week’s crash has led to some of the highest losses we’ve seen since the collapse of FTX, wiping out billions from the crypto market. Bitcoin’s drop to below $50,000 dramatically affected the futures market, with futures open interest plunging from $31.22 billion on Aug. 5 to $26.65 billion on Aug. 6.

Such a sharp drop in just 24 hours was most likely caused by forced liquidations of futures positions due to margin calls. When Bitcoin’s price drops below critical levels needed to maintain collateral, it usually triggers a cascade of liquidations, and over-leveraged traders have their positions forcibly closed.

The wipeout in futures open interest we’ve seen this week shows that a significant number of traders were betting on Bitcoin’s continued rise and were caught off guard by the sudden downturn, leading to a massive reduction in leveraged positions.

On the other hand, the options market remained relatively stable during the price downturn. Options open interest remained almost flat, fluctuating slightly around $18 billion during the weekend.

Unlike futures, options don’t involve margin calls that can force positions to close immediately. Instead, they give traders the right, but not the obligation, to buy or sell BTC at a predetermined price. This inherent characteristic enables options traders to hold onto their positions without the immediate risk of liquidation, even during periods of extreme price volatility.

However, it’s highly unlikely that the stability in options OI we’ve seen over the past few days was due to traders holding onto their positions.

Options trading volume on Deribit surged from $1.22 billion on Aug. 5 to $4.98 billion on Aug. 6. This is the second-highest options volume ever recorded, topped only by the $5.30 billion in volume the market saw on Feb. 29 this year.

Such a high spike in volume indicates heightened trading activity, where traders are actively engaging in the market. Several factors could have contributed to this phenomenon where open interest remains stable while trading volume increases.

Firstly, during periods of high volatility, traders enter and exit positions more frequently, which means opening new contracts and closing existing ones at a rapid pace. If the number of new contracts opened roughly equals the number of contracts closed, the OI will remain relatively unchanged while the volume spikes. A high turnover of contracts could result from short-term speculation, hedging, or rolling over positions.

An interesting aspect of the options market during this period is the skew towards calls over puts. With over 66% of the options open interest being calls, it shows a bullish sentiment still prevails among traders.

However, while open interest shows a strong bias toward calls, trading volume is skewed toward puts. The 24-hour options trading volume between Aug. 5 and Aug. 6 came from puts. This can be explained by the immediate reactions traders had to the price drop. When Bitcoin experienced a sharp decline, traders likely rushed to buy puts to hedge their existing positions or to speculate on further price declines in the short term.

In contrast, open interest reflects more of traders’ longer-term positioning. Most open interest being calls indicates that traders have built up these positions over time, maintaining a bullish outlook on Bitcoin’s longer-term prospects. These positions are not as quickly adjusted or closed as short-term trades, which is why the open interest remains heavily skewed toward calls.

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Changes in futures and options open interest provide insight into market sentiment, liquidity, and potential price movements. Futures and options reveal how traders position themselves and show their expectations for future price action. Open interest measures the flow of money, showing whether new capital is entering or exiting the market.

Looking at open interest, we can see that Bitcoin’s recent rally has brought new life into the derivatives market, which saw a relatively calm and uneventful July. This stability reflected the weeks of sideways price action the market saw. The lateral trend turned positive last week, as Bitcoin started at $56,680 on July 9. The price increase started slowly but began picking up pace from July 14 onwards, when the price surged from $59,205 to $65,025 on July 17.

Futures open interest closely mirrored this price action. On July 9, open interest was $26.97 billion and rose steadily, reaching $33.25 billion by July 17. This rapid increase in OI shows that traders were opening more contracts as Bitcoin broke $60,000, most likely anticipating further price increases.

The options market followed the same trend. On July 9, open interest was $15.94 billion. It rose steadily over the following week, reaching $20.11 billion by July 17. Like the futures market, a notable spike in options open interest was seen from July 15 onwards, mirroring Bitcoin’s price increase. This surge also shows a significant increase in activity from traders, who rushed to capitalize on price movements.

The distribution of calls and puts shows that over 65% of open interest and volume are calls. This means that a smaller percentage of traders are hedging against downside risks and anticipating further price increases on which they want to capitalize. Options provide a mechanism for traders to leverage their positions with controlled risk, which is particularly attractive during periods of price volatility.

The synchronized rise in both futures and options open interest alongside the price increase shows how integrated the Bitcoin market is. As the spot price rallies, it attracts more futures contracts and prompts increased options activity, indicating a comprehensive response from the market using complex trading instruments.

Furthermore, the correlation between open interest and price shows that the derivatives market loves positive price action. Sideways price action leads to significantly lower open interest in futures and options, while price increases attract new money into the derivatives market.

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Timestamps:
Intro: 0:00
Crypto Mom: 0:43
BNB ATH: 2:38
NiceHash: 4:03
Bitcoin ATMs: 5:00
Lightning Network: 5:20
Mt. Gox is Back: 6:11
Gaming Update: 8:00
Facebook Thriving: 9:50
Novogratz Bullish: 10:15
Venezuela BTC: 11:20
Global Money Chart: 12:02
Krown TA: 13:50
Dervatives & Options: 39:53

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Derivatives such as crypto options and futures offer speculators the opportunity to hedge against losses in the value of NFTs.

Using Ethereum as a reference market value, it is possible to use derivative financial products of ETH to offset the risks arising from the possible loss of value of NFTs. 

Indeed, the NFT market is often based on exchanges that take place in Ethereum (ETH), as many of them are in fact tokens based on this blockchain.

Since NFTs are usually sold in Ethereum, their value can be expressed in dollars, or other fiat currencies, but is often calculated and expressed in ETH. 

The NFT market and how to protect against volatility

The market value of individual NFTs varies over time, but the Non-Fungible Token market itself inevitably goes through moments of great expansion and moments of crisis. 

For example, in the past few months, it was experiencing a period of euphoria coinciding with the bull run of the crypto markets in 2021, whereas right now it is in a downturn. 

Those who own NFTs of significant value and want to hedge against the risk of losing market value over time can do so by using various financial products including ETH options and futures.

How do crypto derivatives work

Crypto derivatives have been around for a long time in the crypto space and the market is always very liquid. So it is not at all difficult to find or trade them. 

In fact, the crypto derivatives market is much more liquid than the NFT market, as the world’s leading NFT trading platform OpenSea, for example, trades at a rate of about $70 million a day, while the daily trading volume of crypto derivatives on Binance, for example, is $43 billion. 

One approach that can be used to hedge against losses is futures contracts. Futures contracts allow users to pre-fix the price at which they will buy or sell an asset in the future, so that they can be sure that they will be able to sell it back at a certain price. 

Therefore, people can protect their NFT portfolio in ETH by selling futures at maturity. Generally, futures contracts have an expiry date, so this solution is best suited to those who want to protect themselves against short- or medium-term risks, but not to those who want to do so in the long term. 

Typically, people calculate what percentage of their NFT portfolio in ETH they want to hedge against the risk of impairment by calculating the hedge ratio of their portfolio. After calculating this value, it will be clear how many futures contracts will be required to hedge the risks until they expire.

A similar thing can be done with options, which are derivative contracts that give their holders the right without obligation to buy or sell an asset at a predetermined price. 

These contracts also have an expiration date, so the same reasoning applies as before. Selling operations are called put options, so instead of selling futures it is possible to buy put options. 

Ethereum and the correlation with NFTs

By buying these options, it is possible to sell ETH at a predetermined price in the future, so that any losses in the value of NFTs are offset by gains from the sale of ETH. 

However, it should be added that the NFT market is not perfectly correlated to the ETH market, so these solutions are far from perfect. 

It is therefore not always possible to offset all possible losses in the value of NFTs with gains from selling ETH at a higher price than the market price. In fact, it is a matter of offsetting whose real extent is unknown at the time the derivatives are purchased. 

Another thing to be aware of is the complex nature of these derivative instruments. They are not suitable for all investors or speculators, because before using them, it is highly advisable to find out how they work in order to avoid losses due to errors or misunderstandings. 

Finally, it is necessary to emphasize that these activities are in fact typically speculative, i.e. not suitable for long-term investors, also due to the fact that futures and derivatives have an expiry date. 

Therefore, for an investor who has no speculative ambitions in the short or medium term, they may not be particularly useful, if at all, and may even cause more drawbacks than advantages.

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