Bitcoin volatility expected to increase after approval of options on ETFs, analysts say

The introduction of options on spot bitcoin ETFs, such as BlackRock's iShares Bitcoin Trust (IBIT), is expected to increase the underlying asset's volatility, according to analysts.

On Friday, the U.S. Securities and Exchange Commission (SEC) gave both NYSE American LLC and Cboe Exchange, Inc . the green light to list and trade options on multiple spot bitcoin exchange-traded funds.

Kbit CEO Ed Tolson told The Block that U.S.-based retail traders, who currently lack access to perpetual swap markets , may now turn to IBIT options as a way to achieve an asymmetric payout structure, filling a gap in the market for these investors.

"Retail speculation will likely be the primary use case for IBIT options," Tolson said. "Institutional market makers, who are expected to take the other side of these trades, will likely be short gamma. This means they may need to buy as the price rises and sell as it falls, potentially amplifying volatility."

Galaxy Digital Head of Franchise Trading Michael Harvey also anticipates heightened volatility in the short term.

"We expect retail traders to outnumber institutions initially, which could elevate volatility. Over time, as institutions adopt yield-generation strategies, such as selling volatility, this could dampen the overall volatility we see today," Harvey told The Block.

Harvey emphasized that the regulated nature of U.S.-based spot bitcoin ETF options is also likely to attract institutional investors who are "crypto-curious" but have yet to enter the market.

"This provides institutions a new way to gain exposure to bitcoin, which could lead to a deeper global market for bitcoin options," he said.

SEC ruling states options positions will be capped at 25,000 contracts

The SEC's approval includes strict position and exercise limits, capping positions at 25,000 contracts. This conservative cap, significantly lower than the 250,000-contract limits seen with other ETFs, is designed to reduce the risk of market manipulation and ensure a more controlled trading environment. However, while cautious, Tolson and Harvey do not consider this limit as significantly restricting market activity.

"Even though 25,000 contracts represent around $100 million in notional value, I don’t see it as overly restrictive. There’s already $40 billion in bitcoin open interest across futures and perpetual swaps, so this isn’t a groundbreaking change," said Tolson.

Harvey echoed these sentiments but added that such limits might drive some institutions to explore alternatives. "The 25,000-contract cap is relatively low, which could push institutions toward trading other crypto-related equities like Coinbase or MicroStrategy.”

Impact on the market from bitcoin ETF derivatives

With the expansion of options trading on spot bitcoin ETFs, analysts are closely watching how this will affect bitcoin's overall synthetic notional value and its role in the global financial system. Harvey explained that in other commodities markets, options notional values often surpass the physical supply, which can lead to erratic price behavior. However, he doesn’t foresee long-term price distortion in bitcoin.

"Over time, I believe the interests of speculators and hedgers will balance out, creating a deeper and more liquid market. In addition, stock borrowing and loan markets could reduce the cost of USD in the crypto ecosystem, which may help narrow the gap, or 'basis,' between native crypto markets and CME futures," Harvey said.

Options are financial derivatives that provide the right to buy or sell an asset, in this case, spot bitcoin ETFs , at a predetermined price within a certain time frame. Many in the financial community expect that allowing options on spot bitcoin ETFs will draw more institutional investors to the crypto market while potentially boosting liquidity.