Ribbon VIP: Custom Trade Case Study
Ribbon VIP: Case Study of our First Trade
We recently launched Ribbon VIP, a suite of premium services for our high value and most loyal users. As part of the program offering, we presented the opportunity for our VIPs to enter custom trades that we find relevant to them. Our structuring team monitors dislocations in the market and sends conviction trade ideas each week. So far, we've traded ~$1m in notional volume across 4 trades!
Let us take you through the performance of the first expired trade.
Trade Rationale
In the last week of December, BTC spot was hovering ~$16,750 with implied volatility close to all-time lows. At the same time, market participants were buying out-of-the money call options as the upside skew looked relatively high compared to the rest of the year.
We thought that it would be a good time to go long volatility in a cost-efficient format to ride a potential recovery.
Our rationale was the following: BTC had been consolidating at lower levels for the past month as a result of the FTX debacle. Investors would not want to miss the boat if it suddenly started bouncing back up, but at the same time, they could be worried about further bad news hitting the wire. Basically, they would want to have a skin in the game, but would not want to spend too much, risk too much and lose too much if BTC continued to go down.
One client specifically wanted to “ride an eventual comeback above 20k but without losing it all if we go down”.
We thought buying an up-and-out call option would fit this view perfectly while taking advantage of the low implied volatility and the high upside skew.
Trade Details
An up-and-out call option gives holders the right to buy BTC at a predetermined strike. This part is the same as a plain vanilla call option. The difference is in the knock-out part which consists of a barrier/trigger above the strike, which would kill the option if the price of BTC is above the latter at expiry.
To give a sense of the cheapening of adding the barrier, with BTC at $16,800, the 1-month at-the-money call cost 5.00%, so the trade is profitable if BTC is above $17,685 at expiry.
But, if you add the barrier at $20,500, the price goes down to 3.8%, and the trade becomes profitable if BTC price is below $17,464 at expiry. There is a 24% cheapening by adding the barrier.
We came up with a couple of alternatives as you can observe below and let the client decide what they thought would be best given their risk profile.
Source: Ribbon Finance, 2023.
The exact trade details were the following, the client decided to go ahead with the second variation:
Underlying: BTC
Tenor: 1m
Strike: 95%
Spot Price: $16,650
Knock-out Barrier: $20,500.00
Barrier Type: European (only observed at maturity)
Price: 6.64%
Theoretical maximum loss: Premium Paid
Payout paid in: WBTC
Notional: 37.65 WBTC
The payoff diagram of the trade was the following:
Source: Ribbon Finance, 2023.
Trade Process and Life Cycle
The client deposited in his custom vault the premium to be paid on December 22nd 2022, here 2.5 WBTC and the trade was executed shortly after.
On January 11 2023, with BTC trading ~$17,500, the client requested an early exit and was able to exit the trade with a 0.73 WBTC profit, converting to ~29% profit in WBTC terms or 30.5% profit in USD terms, while BTC only rose ~5% in this time window.
Conclusion
Custom trades offered as part of Ribbon VIP can be used to express specific views through unique payoffs that clients cannot access anywhere else in DeFi. Our structuring team will tailor each trade to your investment objectives and risk appetite while showing you our conviction trades every week. Additionally, you have the ability to monitor the value of the trade in real time and request an early exit at any time to take advantage of changing market conditions.
To Go Further: Entry Point Analysis
By entering this trade, you were implicitly selling the implied volatility upside skew and buying at-the-money volatility, and the former was rich compared to the at-the-money point.
We show below the historical evolution of the 1-month at-the-money implied volatility.
Source: Ribbon Finance, Amberdata, 2023. Data ranging from 01Jan22 to 22Dec2022.
We also show below the historical evolution of the 1-month implied volatility upside skew level defined as (5dc - 35dc) / 35dc, as an indication of how the implied entry point has evolved for this trade.
Source: Ribbon Finance, Amberdata, 2023. Data ranging from 01Jan22 to 22Dec2022.