• Crypto prices mostly range-bound in May
• Market makers’ hedging strategies hold back prices
• Missing narrative for major price action
We are actually used to wild swings in the crypto markets, but things have been comparatively quiet there lately. The prices of the two largest cyber currencies, Bitcoin and Ethereum, mostly moved in a narrow range, especially in May, which according to “Coindesk” was due to competing influences and narratives on the market. But the behavior of market makers is also said to have played a greater role.
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This is how market makers operate in the crypto market
Market makers have the task of ensuring sufficient liquidity on the market. If this is the case, tokens can be easily bought or sold without slippage – i.e. an unexpected price change during order execution – occurring. According to Coindesk, market makers on the crypto market are mainly active in the area of crypto options and offer investors the opportunity to buy or sell a call or put option at any time, even if there is no other investor doing exactly the opposite business want to do.
The market makers provide the necessary counterpart for the trade, but remain neutral themselves by hedging the trade by trading the underlying asset on the spot market or futures market. For example, if market makers sell a call option on Bitcoin that gives the buyer the right to buy the underlying asset at a predetermined price on or before a specific date, they might be hedging themselves with a futures contract that is similar expiration date or buy bitcoin on the spot market. When selling a put option that certifies the right to sell an underlying asset, the market makers protect themselves by taking countermeasures. You are aiming for a delta-neutral position, the total value of which in theory does not change if the price of the underlying asset moves, i.e. the delta is zero.
In practice, however, the delta does not remain constant, but changes with price fluctuations of the underlying. The market makers must therefore constantly adjust their hedging positions in order to remain delta-neutral. The rate of change of delta in response to changes in the price of the underlying is referred to as gamma. “Medium” also describes delta as the amount “market makers must own to remain hedged – while gamma is the rate at which they must adjust that hedge”.
Positive gamma compresses price movement range
In May, according to Coindesk, crypto investors were now heavily betting on short strategies or selling call options in order to “earn a return on top of spot market holdings” with high-risk option volatility strategies. As a result, market makers would have had to take an excess of long call positions, which according to David Brickell, director of institutional sales at crypto liquidity network Paradigm, ultimately resulted in them being “crammed” with a positive gamma. That large positive gamma then forced market makers to “trade against the direction spot prices are moving in order to keep their books delta-neutral,” according to the crypto news site. According to “Medium”, in such an environment, the actions of market makers reduce volatility, and “Coindesk” also says that these hedging measures have kept crypto prices in a narrow range.
“In the case of a positive gamma, the market makers’ delta-hedging behavior is to sell high and buy low, compressing the range of price action near the strike price,” explained Griffin Ardnern, who advocates for a Crypto asset management firm involved in volatility trading futures and options, per the news site. “A negative feedback loop is created as gamma hedging keeps spot ranges limited, which further weighs on volatility,” Brickell told Coindesk. In addition, traders would also try to reduce their long gamma positions, injecting liquidity into the market in the process, which Medium says translates into less pressure on the price of the underlying asset, which remains locked in a narrow range.
The sideways movement of Bitcoin and Ethereum may not change too much in the near future. “Unless there is a catalyst/narrative to take directional risk, this systematic, mechanical volatility selling will continue to matter,” said Paradigm expert Brickell.
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