Cumberland Favors Bitcoin Option Trades to Profit From US CPI

The U.S. Bureau of Labor Statistics is scheduled to release the all-important Consumer Price Index (CPI) figures for November at 8:30 a.m. ET (13:30 UTC) on Tuesday.

If the inflation report comes hot, risk assets, including bitcoin (BTC), may face selling pressure. On the contrary, bitcoin could rally if data shows inflation showing signs of responding to the Federal Reserve's rate hike cycle.

In other words, the CPI release could wake up bitcoin from its recent slumber and trading giant Cumberland recommends an options strategy to profit from the post-data price action.

"Sell BTC June calls and hedge with December options," Cumberland said in the CPI preview published on dominant crypto options exchange Deribit's market insights blog.

The CPI is likely to show the cost of living rose by 7.3% in November on an annual basis, slowing from the 7.7% rise in the previous month. The core inflation, which excludes food and energy, likely rose 6.1% following October's 6.3% increase.

To the uninitiated, bullish call options give the purchaser the right but not the obligation to buy the underlying asset at a predetermined price on or before a specific date. Meanwhile, put options give the right to sell.

A call buyer compensates the call seller for offering protection against bullish moves by paying a premium when the contract is purchased. The premium received is the call seller's maximum profit, while the maximum loss is unlimited, as, in theory, the market can rise to infinity.

Calls gain value when the market rises and bleed when the market drops. Seasoned traders sell higher strike or above-spot price call options when the market is expected to fall or stay flat.

In the trade suggested by Cumberland, the June expiry calls will lose premium, making money for the call seller, if the data shows inflation remained elevated in November. A hotter-than-expected print would dash hopes for a Fed pivot in favor of rate cuts, pushing bitcoin lower and eroding the value of calls.

"There is reason to believe that a high CPI print on Tuesday could be a tipping point, giving risk assets a strong reason to move back towards the downside and thus generating delta P&L through call selling," Cumberland noted.

What if CPI brings risk-on rally?

At this point, the obvious question that comes to mind is, what if the CPI misses estimates, bolstering hopes for the Fed pivot and lifting bitcoin? In that case, wouldn't the June call options gain value, yielding a big loss for the seller?

While call options stand to gain value in case of a bitcoin rally, the rate of gain is likely to be tepid.

That's because the implied volatility, or the market's forecast of a potential movement in the underlying asset, is expected to drop following Tuesday's CPI and Wednesday's Fed rate decision. A drop in implied volatility, which can be equated with lesser uncertainty, benefits options sellers.

"A low CPI should reassert the market’s confidence in inflation coming down, causing a rally in risk assets but bringing vols [implied volatility] down again (generating vega P&L through call selling) as this narrative is already somewhat priced in," Cumberland said.

Options vega measures the amount of increase or decrease in premium based on a 1% (100 basis points) change in the implied volatility (IV) assumption. A call buyer is long vega and stands to benefit from a rise in implied volatility, which can be equated with the degree of uncertainty. On the contrary, a call seller is short vega and will benefit from a drop in implied volatility.

Besides, Cumberland favors buying short-dated options as a hedge against the risk of a potential blowup in volatility in the aftermath of the CPI report.

"One can hedge this trade by buying some gamma (short-dated options expiring in December). The low levels of realized volatility have made the weekly straddle prices reasonably cheap compared to historical levels during data week," Cumberland noted.

"This Friday’s BTC and ETH straddles are priced at 0.0453 and 0.0642, respectively, implying approximate moves of 4.5% and 6.4%," Cumberland added.

Straddles is an options strategy that involves buying both call and put options when they are cheap relative to historical standards and implied volatility is expected to rise. Buying a straddle is akin to taking a bullish bet on volatility.

Readers, however, should note that employing complex options strategies requires active management of position and ample capital supply. That's probably the reason why options market is dominated by institutions and sophisticated traders.