Call Skew Explained

The Crab Trade: A Detailed Analysis of Bitcoin (IBIT) Options

Key Concepts:

• Crab Trade: An options strategy involving buying a longer-dated, at-the-money option, selling two shorter-dated, out-of-the-money options against it, and buying a wing (further OTM option) to define/cap risk.
• Skew: The difference in implied volatility between calls and puts. A positive skew (like in this case) indicates higher demand and therefore higher prices for call options compared to put options.
• Ratio Spread: An options strategy involving buying and selling different numbers of calls or puts with the same expiration date but different strike prices.
• Delta: A measure of an option's sensitivity to changes in the underlying asset's price. (40 Delta, 20 Delta are mentioned)
• Theta: A measure of the rate of decline in an option's value as time passes (time decay).
• Buying Power: The amount of capital required to enter and maintain an options position.
• Defined Risk: A strategy where the maximum potential loss is known upfront.
• Implied Volatility (IV): The market's expectation of future price volatility.

I. Introduction & Market Context

The video details a “crab trade” executed on the iShares Bitcoin ETF (IBIT) following its options launch. The presenter highlights the significant liquidity in IBIT options and notes Bitcoin’s price at approximately $95,000 (implied by the ETF price of $54, assuming a 1:1 ratio). The context is a bullish market, with Bitcoin at yearly highs, making traditional long delta strategies expensive. The focus is on exploiting the observed skew in option pricing.

II. Understanding Skew & Rationale for the Crab Trade

The presenter explains the concept of “skew” using the January expiration for IBIT. Specifically, the 44 put options are trading at $145, while the 64 call options are trading at $310 – a roughly 2:1 skew favoring calls. This indicates that the market perceives a higher probability and potential for upside movement in Bitcoin.

This skew makes ratio spreads on the upside cheaper than those on the downside. For example, a 10-point wide ratio spread on the upside is achievable for a negligible cost, while a similar spread on the downside is only $6 wide for the same value. The crab trade is chosen as a strategy to capitalize on this upside skew. The presenter states, “It doesn't necessarily mean it will go up. It certainly can. uh it just means that the value and the perceived velocity of risk is to the upside in this ETF and in Bitcoin in general.”

III. Constructing the Crab Trade: Step-by-Step

The presenter outlines the specific construction of the crab trade:

1. Long Call: Buy a January 60 strike call option (approximately 40 delta).
2. Short Calls (Ratio): Sell two December 65 strike call options (approximately 20 delta). This is intended to generate initial credit and benefit from time decay.
3. Wing (Risk Definition/Capital Efficiency): Buy a further out-of-the-money call option (initially considering the 75 or 80 strike) to cap potential losses. The presenter initially aims to reduce buying power requirements to around $1000. He ultimately settles on the 75 strike, which requires $687 in buying power. He also explores widening the wing to the 80 strike for a slightly cheaper entry.
4. Optimization: The presenter adjusts the wing strike (eventually settling on the 75) to balance risk management with capital efficiency. He notes that a 70 strike would have resulted in the debit paid equaling the maximum potential loss.

The initial debit for the trade was $189. The goal is to profit if IBIT stays below $65 through the December expiration of the short calls, effectively owning the January 60 call for a reduced cost.

IV. Trade Analysis & Theta Considerations

The presenter uses an analysis tool to visualize the potential profit and loss profile of the crab trade. He highlights the limited downside risk (capped by the wing) and the potential for profit if IBIT remains below the 65 strike.

He emphasizes the positive theta (time decay) generated by the short calls, noting a theta of approximately $2.70 due to the $3 of premium collected from selling the short options. He explains that options trade in increments of nickels, requiring adjustments when placing orders.

V. Trade Update & Results (Post-CPI)

Following the release of CPI data, the market moved upwards, with Bitcoin exceeding $100,000 and IBIT reaching $5726. The presenter reviews the trade’s performance:

• Short Call Profit: The December 65 strike calls, initially sold at $147, are now marked at $0.30, resulting in a profit of approximately $2 per contract.
• Long Call Loss: The January 60 strike call, initially bought at $4, is now marked at $3.55, representing a loss of approximately $0.45 per contract.
• Net Profit: The overall profit on the trade is $120, based on an initial debit of $189.

The presenter states, “We’ve captured basically all of that $2.50 some odds. We’ve lost about 70 80 90 cents on the long option. And we’ve netted out $120 P&L here on just $189 of debit on entry.”

VI. Trade Closure & Final Results

The presenter closes the crab trade for a total profit of $111. He highlights the trade’s risk-defined nature, where the maximum potential loss was equal to the initial debit paid. He concludes by describing it as a “great trade for the boys.”

Notable Quote:

“It doesn't necessarily mean it will go up. It certainly can. uh it just means that the value and the perceived velocity of risk is to the upside in this ETF and in Bitcoin in general.” – The presenter, explaining the significance of the observed skew.

Synthesis/Conclusion:

The video provides a detailed walkthrough of a crab trade strategy applied to IBIT options, capitalizing on the observed upside skew. The trade demonstrates a method for generating profit in a bullish market while managing risk through the use of a wing option. The presenter emphasizes the importance of understanding skew, delta, and theta in options trading, and highlights the benefits of a risk-defined strategy. The successful execution and closure of the trade illustrate a practical application of options theory and trade management techniques.