Observations on Token Derivatives - Part One

In Part 1, we introduce FTX’s MOVE Contract with profit and loss visualisation, and how to use the MOVE Contract. Derivatives have become a competitive field in cryptocurrency trading. Whether it's traditional complex derivatives like options, or unique and innovative derivatives in the cryptocurrency industry like leveraged tokens, it's all relatively new for most users. Naturally, there are huge opportunities. Opportunities for the exchange lies in the liquidity, while opportunities for users come from the pricing problems caused by the lack of liquidity in the early stage and some loopholes in the understanding of rules. Speaking of innovation in derivatives, FTX released the MOVE contract before China’s National Day. It is a form of investment that allows users to bet on volatility, resulting in profits whether or not the user longs or short Bitcoin. In line with the principle that all derivatives has its application scenario, this paper explains the ways to use this contract in detail, and the scope of application as a trading tool.

1. Basic Introduction of MOVE

MOVE contract is a double option contract created by FTX. It is used to bet on the absolute value of the price fluctuation of a cryptocurrency (currently Bitcoin) in a day (starting at 8 a.m. Beijing time). For example, if Bitcoin's price yesterday was 8000, and today's delivery price became 8200. Then no matter how big the price fluctuation, the final delivery price is 200 yuan. The buyer is the side who longs volatility. If the buyer buys at a price lower than 200 yuan on the same day, he/she gains profits at the time of delivery. The seller is the side who shorts volatility. If the seller sells at a price higher than 200 yuan on the same day, he/she gains profits at the time of delivery. [caption id="attachment_16881" align="aligncenter" width="620"] CoinTelegraph[/caption]

Profit and Loss Diagram of Both Parties

Suppose that the benchmark price of Bitcoin on the previous day is S, the current price is P, the Bitcoin delivery price is St, the current MOVE contract price is X, the expected delivery price is |P-S|, and the final delivery price is |St-S|. Buyer's Profit and Loss Illustration: The buyer’s cost is X, The closing proceeds are | St-S |. The final income is | St-S | - X. Therefore, When St < S-S, or St > S + X, the buyer's profit is positive. When S-X < St < S + X, the buyer's income is negative The maximum loss is - X, with limited cost and unlimited income. Since S has been determined, the smaller X gets, the more benefits the buyer obtains.   Seller's Profit and Loss Illustration: Contrary to the buyer, seller earns a net income of X - | St-S|. When the final delivery price St is between S - X and S + X, that is, S - X < St < S + X, the seller's income is positive. On the contrary, when St < S - X, or St > S + X, the seller will have a net loss. The seller’s maximum profit is X, with limited profit and unlimited loss. As S is fixed, the higher the X, the more beneficial it is for the seller. To see it more directly, the following shows how the actual trading interface looks like: The marked price is simply understood as the current MOVE price, and the bet price is the benchmark price measured by the absolute value of today's volatility. The expected delivery price is the absolute value of the index price minus the bet price. To supplement, there are some other rules:

1. The starting price and delivery price are determined by the weighted average price of the previous hour. This is to avoid the impact of the drastic fluctuation of the underlying asset price.
2. The profit of MOVE buyer is similar to that of futures: margin is required to buy and sell MOVE contracts, and the margin requirement is roughly the same as that of a BTC futures contract.

That is to say, although the MOVE contract is only $100, buyers need to pay a deposit equivalent to 1 Bitcoin. Suppose BTC is worth $8500, even if it can apply 10 times of leverage, it still needs a deposit of $850 to buy a MOVE contract.

If there is no time value, its income is basically the same as that of futures.

Buying MOVE doesn't give full play to the high pay-off odds feature of call options. This should be related to the principle behind how FTX created MOVE.

3. There will be two MOVE contracts at the same time, one for the same day and the other for the next day (i.e. 8 a.m. Beijing time).
4. The administrative fee is more expensive: it’s administrative fee is similar to the fees incurred for opening futures, for example, for a $100 MOVE contract, 8500 * 0.07% = 5.95 USD is also required.

Check the following website for more detailed information.

2. How to Use the MOVE Contract?

2.1 It is Related to the Gamma & Has Nothing to do With the Vega Unlike common options, MOVE contracts only bet on a day’s change in BTC price, so it is difficult for the volatility to be reflected onto the price. Hence, relatively speaking, the influence of various Greek letters in options on MOVE contracts is limited; the main contradiction is the change of absolute volatility. 2.2 The Concept of Time Value In traditional options, time value is the residual value after the premium minus the intrinsic value of the option. The closer the time is to maturity, the smaller the time value is, and vice versa. In MOVE, because there is only a one day period, time value can be understood as (actual price - expected delivery price), and the time value gradually decreases. For example, MOVE price is 200 at 8:00 a.m. on a certain day. Since 8:00 a.m. is the starting time and the expected delivery price is 0, there is a price difference of 200 yuan between the MOVE price and the expected delivery price. Assuming that the BTC price does not change much, MOVE price will gradually fall close to the expected delivery price.

Decay of Time Value Graph of the MOVE Contract

(Legends from left to right: 27 September to 7 October)

The graph above shows the decline of time value of MOVE from 27 September to 7 October.

It can be seen that time value decreases with time.

When the MOVE contract was just launched, BTC’s fluctuation was relatively high; the opening price of the contracts were also high (generally more than 200), and the time value decay was slower (the time value tended to show a linear downward trend). With the decline of BTC fluctuation and the deepening of users' understanding of MOVE contracts, the opening value of contracts took a downturn (generally below 150), and the time value tends to decline almost to zero in half a day. 2.3 How Does the Seller Operate?

1. A) Source of Profit

The seller has two sources of profit, one is to collect the time value, the other is the return of absolute volatility. For the time value, the greater "X - | S - P |" is, the higher the time value.

The seller’s goal here is to consume the time value.

When the time value is low, shorting MOVE is actually a bet that futures will fluctuate in the opposite direction. Taking the MOVE contract on 5 October as an example, the relevant price changes are as follows:

1. B) When to be the Seller?

For users who want to earn time value, the higher “X-S” is, the higher the potential profit from being a seller, and the lower the sensitivity of price fluctuation (lower delta) of BTC, the higher the security cushion. Therefore, it is a good time for the seller on the day MOVE contract opens and the next day when it is high. For users earning volatility call-back, there is no substantive difference with the subjective timing of futures rally or shorting from a high price. However, it should be noted that at this time, the price of MOVE contracts must also be at a high level.

1. C) How Does the Seller Manage Risks?

For users who want to earn time value, since the best timing to short is at its opening, the most favourable situation is that the expected delivery price remains low, and the contract price X approaches to 0. However, as X approaches 0, the time value decays, and its own risk increases.

Therefore, as a seller, we should not only consider the balance between time value and risk accumulation, but also consider the risk when the absolute value of volatility rises rapidly.

What’s Next?

In Part 2, we continue discussing how to use the MOVE Contract by understanding how does the buyer operate. Further, we discuss the practical results of the strategy and before we conclude, we discuss some problems with MOVE and thoughts on potential improvements.     

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Translated by (via our WeChat Account): Xin Yue

Editor: Daphne Tan