'Systematic Bitcoin Call Overwriting' strategy for 2023

Key points: 

• A systematically covered call strategy is often better than a buy-and-hold strategy in markets without a strong upside. 
• Covering involves regularly selling call options with weekly expirations while owning the underlying asset.
• An example of call coverage is when an investor owns Bitcoin and sells his call with a strike price above the current market price.
• However, the strategy puts the rewriter at risk of missing out on a significant increase in the price of Bitcoin. 
• Matrixport doesn't expect a Bitcoin bull run in 2023.
• Due to FTX, implied volatility has increased and made call options more expensive. So now is a good time to override the call.

According to crypto services provider Matrxiport, one of the best ways to participate in the crypto market next year is to continue to offer insurance against rising Bitcoin prices.

The strategy, known as a systematically covered call, is often better than a buy-and-hold strategy in markets without a strong upside, and Matrixport said it doesn't expect a Bitcoin bull run in 2023.

"With the industry likely to experience months of uncertainty, a 'weekly systemic call coverage strategy' could emerge as a winner," Markus Thielen, head of strategic research at Matrixport, said in a note to clients on Friday.

Covering involves regularly selling call options with weekly expirations while owning the underlying asset. In practice, this means ensuring counterparties are against rising prices, as they have the right — but not the obligation — to buy the asset at a specified price on or before the maturity date. The call buyer is implicitly bullish on the market and compensates the seller for the insurance provided by paying an insurance premium.

For sellers, the premium adds the percentage of their income to their annual return. Additional income is limited to the premium amount.

An example of call coverage is when an investor owns Bitcoin and sells his call with a strike price above the current market price. For example, an option buyer is given the right to buy Bitcoin for $20,000 if the current price is $16,400. If the price exceeds $20,000 before the option expires, the option buyer has a chance to profit.

However, the strategy puts the rewriter at risk of missing out on a significant increase in the price of Bitcoin. As a call option seller, they are obliged to sell the underlying asset if the option buyer wishes to exercise their call option, which is likely to happen when the market price is higher than the strike price.

"The biggest risk to this strategy is that the market will have a violent bull market and high volatility due to excessively leveraged returns like we saw in early to mid-2021," Thielen said, downplaying a return of volatility in 2023.

“Exchanges have reduced leverage since summer 2021, and in a post-FTX crypto world regulators are likely to scrutinize retailers’ ability to gain leverage, so offering customers excessive leverage seems unlikely,” Thielen commented road.

Option demand and prices are closely related to the market's level of uncertainty, realized (or historical) volatility, and expectations of price volatility (also known as implied volatility). And volatility reverts to the mean, so experienced traders sell options (calls, puts, or both) when volatility is high and buy options when volatility is low.

According to Thielen, the recent implosion of the cryptocurrency exchange FTX and the resulting contagion fears have increased implied volatility and made call options more expensive. So now is a good time to override the call.

“Recent stress in the crypto world has boosted volatility above the five-year moving average. Increased volatility has increased the value of call options. Therefore, since the strategy can sell higher premium call options, the strategy becomes more attractive," Thiele said.

According to Matrixport's backtesting model, the syscall coverage strategy has produced double-digit annual returns over the past two years. That’s impressive considering Bitcoin’s recent drop to two-year lows below $16,000 completed a round trip.