What Options Data Tells Us About The Ethereum Price Boom

Data from the options market is often the basis for making long-term macro price bets. Currently, investors are looking closely at the Bitcoin options market to see if a Gamma squeeze may be building up for the asset. A gamma squeeze happens when the underlying price of an asset begins to rise sharply over a short period of time because of interactions between the spot and derivative market.

In crypto, for much of 2022, there has been a bearish cloud reigning over markets. The cloud has been created by concerns surrounding a bleak global macro environment that may lead to a recession. A recession would likely negatively affect the spending power and risk aversion of normal crypto investors. Many market participants have already been forced to cash out of digital asset positions to cover for losses.

Overarching bearish sentiment can represent an opportunity for some institutional participants willing to counter trade general sentiment crypto markets. There is an ample, accessible market for crypto derivatives. It has often been suspected that large players have the capabilities to influence the prices on the spot market through the derivative markets.

A gamma squeeze is one of the more conditional derivative-to-spot market scenarios. The conditions of a gamma squeeze are.

• Dominating bearish market sentiment
• The underlying asset has poor liquidity
• The underlying asset has usable derivatives market infrastructure
• There is some underlying bullish narrative that may reverse sentiment.

There are likely only two assets in crypto that have robust enough options markets to meet the 3rd condition – Bitcoin and Ethereum.

On July 16th, market maker liquidity network Paradigm began to report that large bids were coming through for out-of-the money call options for Ethereum. The calls were out of the money because the strike price was higher than the price of Ethereum at the time.

Source: Twitter user @tradeparadigm

The way market makers hedge risk when selling calls is by buying spot or long perpetual contracts to maintain risk neutrality. The buying pressure this created pushed some of the out-of-the-money to in-the-money. This forced market makers into further hedging measures that involved buying spot ETH or long perpetuals, further pushing the price up.

The reason that market makers had to buy crypto spot is to remain market neutral. If the price of the call options were to rise above the agreed-upon price then the buyer would have the right to buy the asset at lower than market rates. Market makers buy spot to ensure that their risk is covered if call buyers suddenly become profitable.

While the price of ETH was already rising because of the interaction between market makers and call options buyers, retail traders were speculating on whether the price jump was being driven by bullishness surrounding the merge and other factors like a soft interest landing from the Fed. The existence of these macro tailwinds drove investors to buy Ethereum and this created pressure on top of the action in the options market. The relative illiquidity of Ethereum markets meant it didn’t take a large money injection to push the price of the asset up rapidly.

Between the 16th and 22nd of July, the price of Ether jumped from US$1221.35 to US$1531.43. This constituted a 29.60% price increase in just six days.

Conclusion

Market observers watched in awe as the price of Ethereum enjoyed a strong bullish reversal. The upcoming merge update was considered the key fundamental factor behind the alpha price gains. Studying data from the options market, however, indicates that a gamma squeeze played a major role in the asset’s strong price performance.

Interactions between market makers, call option buyers, and retail speculators were all factors that contributed to the price jump. This isolated case study reveals that there is more than meets the eye when the price of a digital asset rises or falls. Eagle-eyed traders tracking the options market may have caught wind of the price swing and captured a profit opportunity.