A $130M crypto quant nets big returns as options boom

Forget Elon Musk tweets, regulatory missives and Bitcoin’s energy consumption.

To hedge fund manager Shiliang Tang, the biggest crypto story this year is taking place in the shadows: An options market that’s booming and shaking up digital-currency trading along the way.

At his $130 million fund LedgerPrime, filled with Wall Street converts from the likes of Virtu Financial Inc. and Cantor Fitzgerald LP, Tang is minting money trading derivatives on virtual tokens.

The Bank of America Corp. and UBS Group AG alum is making markets in options and running systematic strategies like price arbitrage and momentum across exchanges. The reward: a 78% return this year in his flagship fund.

“The opportunity seemed larger given the inefficiencies,” said the chief investment officer in an interview from Miami. “There’s so much innovation and new products being launched in crypto.”

Derivatives Boom

Fed by relentless demand for leverage and hedging strategies, the crypto derivatives complex is getting bigger, ever-more liquid and increasingly influential. With Bitcoin still up around 250% over the past year despite heart-stopping swings and the recent downslide, new venues of speculation from decentralized finance to futures contracts have exploded to meet the insatiable appetite to trade.

Consider the options market. An average $1.4 billion in notional amount changed hands every day last month at the largest options exchange Deribit, a nearly 13-fold jump from 2020. Open interest in Bitcoin contracts now totals $7 billion.

And a growing cohort of money managers and retail traders are selling crypto options for yield — a common strategy in mainstream assets and a sign the industry is growing up fast.

Options change hands on the CME, the largest derivatives exchange in the world, in addition to more specialized venues like Binance, Huobi and LedgerPrime’s sister company, LedgerX. Even Goldman Sachs Group Inc. is mulling a move into Ether derivatives.

Glorified Casino

To critics, it’s all a glorified, largely unregulated casino with little real-world utility that could easily come crashing down — with Chinese regulatory curbs the latest threat.

Yet in Tang’s telling, the industry bears similarities to his old stomping grounds on Wall Street, with tried-and-tested systematic strategies in stocks and bonds gaining popularity in the world of virtual currencies. Like traditional market-makers, Tang’s firm posts bid and ask quotes on options venues and makes money from the spread, which tends to be wider in more volatile assets.

Still, this is crypto, of course — a wild west. Liquidations can happen before a trader has the chance to top up collateral. And there’s no central clearing house, so LedgerPrime needs to manage its positions at every venue individually. All this helps explain why Bitcoin slid precipitously last month.

“It’s not like they’ll slowly liquidate your positions — they basically just market sell or market buy your leveraged positions and blast through the book,” Tang said, referring to the exchanges.

For many, the mania is part of the appeal. New products appear so quickly that even as one inefficiency narrows, another soon materializes across one of the hundreds of exchanges out there. And all these opportunities are drawing a more professional crowd, with institutional investors representing some 80% of flows on Deribit.

A hot trend right now is selling options for yield in a wager that crypto price swings will be lower than the market has priced in. Since that’s akin to earning premiums on an insurance policy, it can be hugely profitable — and risky — with an asset like Bitcoin.

The token’s one-month implied volatility, a key variable in option pricing, trades around 100 and soared to as high as 165 in last month’s wipeout, according to Deribit. The S&P 500 equivalent right now? Around 20.

Selling crypto options is proving especially lucrative as returns diminish in trades like the spot-futures basis.

“In the absence of interesting yields for these alternatives, option strategies become more relevant,” said Deribit chief commercial officer Luuk Strijers.

The upshot of all this is that option volumes are getting big enough to sway spot prices. Dealers like LedgerPrime buy underlying tokens to hedge their own exposure — adding momentum to both rallies and retreats in what’s known as a gamma squeeze.

Tang’s tip: Watch spot moves around 4 a.m. in New York every Friday, when most options contracts expire.

“Option flow can definitely drive some of the shorter-term price action,” Tang said. “Longer-term, it’s still supply and demand.”

–Justina Lee, Bloomberg Mercury