Matrixport Favors 'Systematic Bitcoin Call Overwriting' Strategy for 2023

One of the best ways to participate in the crypto market next year is by consistently offering insurance against a bitcoin (BTC) price rally, according to crypto services provider Matrxiport.

The strategy, known as systematic call option overwriting, often outperforms a buy-and-hold approach in a market without a strong bullish direction, and Matrixport said it doesn't foresee a raging bitcoin bull market in 2023.

"'The 'weekly systematic call overwriting strategy' could be a winner as the industry likely moves through several months of uncertainty," Markus Thielen, Matrixport's head of research at strategy, said in a note to clients on Friday.

Overwriting involves regularly selling weekly expiry call options while owning the underlying asset. In effect it means offering insurance against price increases to the counterparty, because they have the right – but not the obligation – to buy the asset at the predetermined price on or before the expiry date. A call buyer is implicitly bullish on the market and compensates the seller for offering insurance by paying a premium.

For the seller, the premium adds extra percentage points of income to their annual return. The extra income is limited to the size of the premium.

An example of call overwriting is when an investor owns one bitcoin and sells a call option on it at a strike price that's higher than the current market price. For example, giving the option buyer the right to purchase the bitcoin at, say $20,000, when the current price is $16,400. If the price tops $20,000 before the option expires, the option buyer has an opportunity to make a profit.

The strategy, however, exposes the overwriter to the risk of missing out on a large increase in bitcoin's price. As a call seller, they are obligated to sell the underlying asset if the option buyer wants to exercise their purchase right, which is likely when the market price moves above the strike level.

"The biggest risk for this strategy is a raging bull market with high volatility due to excessive leverage returns, as we have seen in early-to-mid 2021," Thielen said, downplaying the prospect of a renewed upside volatility explosion in 2023.

"Since the summer of 2021, exchanges have cut down on leverage, and offering customers excessive leverage seems unlikely in a post-FTX crypto world when the regulator will likely take a close look at retail’s ability to access leverage," Thielen noted.

The demand for and prices of options are closely tied to the degree of uncertainty in the market, realized – or historical – volatility and expectations for price turbulence, also known as implied volatility. And volatility is mean-reverting, so seasoned traders sell options (call, put or both) when volatility is elevated and buy options when volatility is cheap.

According to Thielen, the recent implosion of the cryptocurrency exchange FTX and resulting contagion fears have lifted implied volatility, making call options pricier. Therefore, now is a good time to overwrite calls.

Bitcoin's realized volatility has bounced to its five-year average, making call options costlier.

"The recent stress in the crypto world has lifted volatility above the five-year moving average. The rise in volatility has increased the value of calls. Hence this strategy has become even more attractive now as the strategy can sell calls for a higher premium," Thielen said.

According to Matrixport's back-testing models, the systematic call overwriting strategy would have generated double-digit annualized returns in the past two years. That's impressive considering bitcoin recently fell to a two-year low under $16,000, completing a round-trip.

Matrixport's backtesting models show the strategy would have yielded double-digit annualised returns over the past two years.