1. Nowhere to Hide…
1.1 Worst year in history
1.2 Did anything work?
2. Upcoming Risk Events
3. Trades Update
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- Nowhere to Hide
- 1 Worst year in History
Into the last quarter of the year, 2022 has now become the worst performing year in history for a cross-asset portfolio, even eclipsing the stagflationary 1970s!
In our 2022 outlook piece released last December, we wrote that we expected asset price performance this year to be akin to the 70s – when low growth and high inflation meant asset prices stagnated for almost the entire decade.
However, despite the correct call, we were still left surprised by how poorly macro assets have performed across the board. Outside of energy, the breadth and correlation of underperformance is stunning – every single macro financial benchmark is underwater in real terms (Chart 1).
Even commodities such as Gold, Agriculture and Oil, which surged during the Ukraine war in Q1, have now retraced all the way. Gold is close to double-digits in the red YTD in real terms, while the Bloomberg Agri Spot Index is underwater as well.
Most damaging of all has been the positive correlation between fixed income and risk assets, which meant that there were no liquid hedges available for the trillion dollar long-only portfolios this year. The 10y Treasury future benchmark is down over 20% in real terms, while even holding cash and compounded with the Fed’s high overnight rate (SOFR) would still have guaranteed a negative real return.
Worse still, with the strength of the USD, holding cash in your local currency instead would mean even larger double-digit percentage declines in your purchasing power globally.
During the Great Financial Crisis (GFC) crash of 2008, Treasuries and other Government bonds still had large positive real returns, which meant investment portfolios still had an effective hedge available. Today, with every category of fixed income returning negative real returns – there was essentially nowhere you could have hidden out this year and beaten inflation.
1.2 Did anything work?
With all major assets recording sizable double-digit negative real returns, it is no surprise that the highest beta crypto sector has been hardest hit, with 2021 darling assets like Solana down over 90% YTD.
Stablecoin lending rates, a sign of the underlying sentiment in the crypto space, have fallen from the 15-40% annualized levels last year to a paltry low single-digit that doesn’t even match the Fed’s rate, let alone beat inflation (Chart 2).
Looking at these performance statistics, it is easy for many to write crypto off going forward.
However, as we have been alluding to in most of our publications this year, there has been a standout asset class within crypto that has been performing all year – and that is the Volatility market.
The reason why crypto options have been the huge standout asset of 2022 is that as adoption in other parts of crypto reaches saturation levels, options adoption continues growing strongly – on the back of ever-growing institutional interest in crypto from as a reliable, high beta, 24/7 traded speculative macro asset.
This is also the reason why crypto options trading volumes and open interest (OI) have held up so well this year, amidst a crypto winter that has seen other crypto asset class volumes decline between 70-90%. In Q3, ETH options OI actually broke its all-time highs! While BTC OI has held up comparatively well as well (Chart 3).
To illustrate the outperformance of a typical vol-based strategy, we present the results of selling weekly strangles (both put and call) for BTC in a systematic way. Premiums are collected upfront and compounded the next week. Also, all in-the-money contracts are cash-settled at expiry (seller pays the difference between exercise price versus strike price).
The table below shows the results for the strategy from least to most aggressive (the “Delta” number is an indication of how far the option strikes are from spot price at execution; the higher the number, the closer the strikes are to the spot price). “Total Return YTD (annualized) is the net return from all premiums earned minus losses from exercises when the options are in-the-money at expiry.
The results range from a return of -1% annualized for the lowest delta strangle to 87% annualized for the 45 delta strangle (Chart 4).
This result will come as a surprise to many who assume that 2022 has been a disaster for option sellers given the outsized volatility. However, elevated implied vols (option premiums) have made systematic vol selling in BTC a profitable strategy.
While the returns themselves are stand-out for a bear market full of large drawdowns, most impressive of all has been the high sharpe ratios of vol-based strategies throughout the year, in spite of the sharp moves in spot prices we saw this year..
The absolute returns for the 45-delta strangle (Chart 5) show the consistency of returns for even a basic vanilla option strategy. This is the best example that the crypto options market is a key segment that is experiencing exponential growth and offers decent returns.
2. Upcoming Risk Events
3. Trades Update
The options portfolio demonstrates the high probability nature of the trading strategy with a 77% positive hit rate, and average profit APY of 33%.
The only 2 losing trades were the only 2 tactical trades – experimental exotic options trades intended to roll the steady profits from the rest of the portfolio exponentially.
Most of the book’s positions now closed/expired going into the final 2 months of the year. At the year-end trades update in December, we will outline our thesis for next year and reposition the book in a big way going into 2023, just as we did for 2022 last year.
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Disclaimer
