So in reality having a solid options market would actually increase the liquidity of bitcoin but not necessarily decrease the volatility. But it's unlikely to increase the volatility, correct?
Correct
Think of options as side bets. Traders use options because of leverage. So they are not buying or selling bitcoin they are trading contracts on the side betting if bitcoin goes up or down by a certain date.
But options market makers are mostly writing the options. Its really risky for them to do this so in order to hedge these bets they buy or sell the underlying. Its called delta hedging. Delta us how much the option mives w the stock. The stock is one delta. The more "in the money" the higher the delta. Market makers don't care about direction. They make money on premium and the premium is priced using volatility
When a product has options it gets traded a lot. But its the same shares being passed back and forth by the same group of market makers. This is why liquidity increase. If you need to buy or sell the market maker takes your order. You don't need to wait for a buyer or seller on other side.
Seems like it would be a net positive for bitcoin. I wonder why there is so much resistance to the idea of bitcoin options. Misinformation maybe?
I dont trade bitcoins but I looked on coinbase and the bid ask spread is $2. That is crazy wide. When AAPL was $600 the bid ask spread was still only 10c.
If there were options on bitcoin that increased liquidity the bid ask spread might go down to about 30c.
The spread is that wide because Coinbase needs to earn a profit and they need to manage risk when buyers are buying from them. The spread on most exchanges is usually much lower but you do need to pay trading fees (~.2% usually - for most customers). If you were to buy AAPL you would still need to pay some kind of commission which would make your "spread" higher.
I don't think that bitcoin has a liquid enough of a market yet to have options and other derivatives based on it's price. Trading volume is high enough so that most people can easily buy or sell the amount of bitcoin they need but is still low when compared to most stocks with similar market caps, and tiny when compared to currencies. ForEX trade volume is measured in the trillions of dollars per day while bitcoin exchange trade is measured in the tens of millions of dollars worth per day.
Options and basic derivatives can reduce volatility on the underlying instrument in general as people who are afraid that the price will go down would not be forced to sell, but instead could purchase put options which would have a lower effect on the market (it would still have some effect as the seller of the put option would need to hedge his risk). When you have derivatives that are complex and that are measured in frequent time periods then they can add to volatility in times of high volatility. One example of this are the ETFs that are designed to get 2x (and 3x) the daily return of the Dow Jones Industrial Average. When volatility was already high the market would have swings in price in the last 30 minutes of trading that would be several time of the swings of prices that occurred for the rest of the trading day. Since these ETFs had to rebalanced their holdings every day so they can get 2x the return of the underlying the following day they were the cause of these huge price swings.