Trading for options on ether futures contracts has begun for institutional investors who want a way to manage risk.
The CME launched ether options on Sept. 12, ahead of the Merge.
The Merge is a major crypto event because it is a software update of the Ethereum blockchain, which is considered the internet of the crypto space. The Merge is set for Sept. 15 and if no hiccups occur, a huge step will be made in the crypto industry to build trust among investors, crypto enthusiasts say.
The merge will impact the second largest blockchain network by changing its transaction consensus mechanism from Proof-of-Work (PoW) to Proof-of-Stake (PoS), wrote Payal Shah, director of equity research and product development at CME Group.
Ethereum is home to over 3,000 decentralized applications, ranging from games to trading to even loans. Various trends have emerged on ethereum, such as initial coin offerings, decentralized finance, nonfungible tokens and the metaverse.
Investors buy puts to protect against the downside and sell calls to collect extra income if they believe the upside is limited.
These new contracts deliver one Ether futures sized at 50 ether per contract and based on the CME CF Ether-Dollar Reference Rate, which serves as a once-a-day reference rate of the U.S. dollar price of ether.
Ether options settle into liquid Ether futures, which are based on the regulated CME CF Ether-Dollar Reference Rate. Micro ether futures began trading in December 2021.
“We had a strong interest from customers to have a larger-sized contract to have a better way to manage ether risk,” Tim McCourt, senior managing director, global head of equity and FX Products at CME Group, told TheStreet. “Options are a very useful tool for pre and post merge of ethereum.”
Institutional clients wanted to use options alongside a larger-sized ether futures contract, he said.
The CME began trading options on Ether futures at 6 p.m. ET on Sept. 11 and institutional clients made several large block trades, McCourt said.
“The larger-sized contracts provide the opportunity to have more price discovery, arbitrage opportunities and hedging certain activities,” he said. “The institutional clients operate in regulated frameworks and want to benefit from the transparency of prices and have the standard benefit of futures and options,” he said.
Institutional traders have shown more interest in micro ether options compared to micro BTC options - during the third quarter, the number of micro ether options rose to 3600 contracts a day compared to 600 during the second quarter while micro BTC options contracts were more muted with contracts rising to 600 during the third quarter from 400 in the second quarter daily.
One reason there could be more trading of ether futures is that the Ethereum network provides more organic needs for ether as decentralized products and services such as NFTs increase and as ether volumes increase there will be increasing risk management needs in doing business in protocols and functions powered by the ethereum network and associated ether-based transaction fees.
“There will be more inherent risk management needs in blockchain projects as more ether players and protocols increase their use cases with more testing and development,” McCourt said. “Ether is what powers that network and is becoming more involved in blockchain tech, making it more and more of a commercial use case.”
Both the options on ether futures contracts and micro ether futures contracts are agnostic to the Merge since the exposure is synthetic. The derivative products provide synthetic exposure.
“Our new options contracts will also complement CME Group's micro Ether futures which have seen a 43% increase in average daily volume year over year," he said.
Trading in ether futures and micro ether options trading reached record levels, according to the CME.
The micro ether options' average daily volume (ADV) in August was more than 5,260 contracts, up over 130% from July.
The micro ether options open interest reached a record of 124,814 contracts on Aug. 30 while the average daily open interest in August reached a record of 75,959, up over 135% since July.
The average daily volume of ether futures reached a record 7,042 contracts in the third quarter, up 52% from the third quarter in 2021.
High inflation rates and the aggressive rate hikes by the Federal Reserve have increased the risk to crypto investors, so they need tools to effectively manage it such as ether options, Jodie Gunzberg, managing director of New York-based CoinDesk Indices, told TheStreet.
“The options allows ether investors to essentially buy insurance for a set time to protect against the risk of a loss beyond a set tolerance,” she said.
If an ether investor decides they want to protect against a potential loss from the Ethereum merge, the options may help with that and if ETH goes up, only the premium paid will be lost - just like insurance, Gunzberg said.
“Owning a put option is buying insurance and selling a call option is selling insurance,” she said.
“These options can also provide a highly correlated protection against losses in smaller digital assets of the smart contract platform sector, represented by the CoinDesk Smart Contract Platform Select Ex ETH Index (SCPXX), tracked by Grayscale® Smart Contract Platform Ex-Ethereum Fund (GSCPxE),” she said.
Aside from using risk management, options can be used to develop trading strategies on ETH or allow investors to get exposure “without going directly into the crypto spot market if they feel more comfortable using the traditional tools they know,” Gunzberg said.
Investors can manage risk without derivatives by either limiting position sizes or by intentionally diversifying with lowly correlated assets, she said.
“In crypto as the market is growing by the number of digital assets with different technologies and use cases, their performance by sector is variable with some uncorrelated industries to provide better risk adjusted returns and potentially protect from adverse macro conditions, which is now measurable by the CoinDesk Market Index family,” Gunzberg said. “The idiosyncratic risk can play a big role in diversification as we have seen with the recent outperformance of ether vs. bitcoin, driven by the merge that overpowered the macro headwinds.”
Strong demand for the ether options contract is anticipated, said Rob Strebel, head of relationship management for DRW, a Chicago financial services company.
"Options are an essential part of the trading strategy deployed by Cumberland's institutional counterparties, whether that's to hedge risk or gain exposure to the asset class without having it on their balance sheets,” he said. “The CME Group has proven trading and clearing infrastructure backing the product and we're excited to provide liquidity on day one.”
