- Darius Sit built crypto trading firm QCP Capital from a 2-man prop shop into a crypto options empire.
- In the past week, they’ve traded $250 million notional in DeFi options. He explains how they work.
- And he shares how the team is positioned in a market where the near-term is bullish, but risks also lurk.
Many of the top crypto trading firms and traders formed out of the 2017 bull run where they capitalized on a highly lucrative trade known as the “kimchi premium”.
This was the gap in bitcoin prices on Asian and Western exchanges. There was a vast spread of around 50% at its peak between exchanges in South Korea and the US.
This trade helped 29-year-old Sam Bankman-Fried become a crypto billionaire. He capitalized on the arbitrage opportunity between Japanese and US exchanges and netted himself 10% daily returns on million-dollar crypto trades.
Another under-the-radar trader that created a monster operation off the back of this very sort of trade is Darius Sit.
In 2017, Sit left his job at BNP Paribas managing the bank’s FX Asia team when he realized he could do 30% to 60% arbitrage trades in decent sizes in crypto. Four years later, he had gone from a prop shop team of two, to a massive crypto trading operation known as QCP Capital.
This growth comes down to the team’s dominance in the options market.
“In 2020, we actually kickstarted the ether [options] market,” Sit said. ” …Before 2020, ether market was a dead options market … we brought the market up and now we’re doing the same thing in DeFi.”
Options are derivative products that give the buyer the right, but not obligation, to buy or sell the underlying asset at a fixed price and within a specified timeframe.
“We run a $2 billion book in options,” Sit said. “It’s very institutional in size and in a sweet spot where we have very high
volatility
, but also trying to get scalability and all more importantly, there’s a lot of growth still to be had.”
DeFi options
This growth can be found in the decentralized finance space where once again Sit and his team are pioneering options. In the past week, they traded $250 million in notional in DeFi options that trade on decentralized exchanges, according to a recent note.
“In crypto options, you’ve really got a chance to make a difference and also make some money,” said Simon Nursey, QCP’s head of derivatives and the former global head of options trading at BNP Paribas.
The volatility surrounding the underlying assets in crypto create much more opportunities for investors compared to traditional markets. Insider recently spoke with Jakob Palmstierna, head of product for leading trading firm GSR, who explained how covered calls in cryptocurrencies can generate handsome returns for investors.
“If you compare FX volatility to crypto volatility, you have a very volatile currency maybe that’s the dollar/India and you implied volatilities that are trading at around 4% to 5% versus crypto you have bitcoin and ether trading at almost 100% implied volatility and altcoins even higher than that,” Sit said.
Investors can expect average real yields of 15% to 50% in DeFi options, depending on the strike price, according to the team.
However, setting up options in the decentralized finance space, where the goal is to have no intermediaries is challenging and makes it difficult to have primitive order books and to offer leverage.
The team have set up a solution called “option vaults”, a hybrid decentralized finance model, where the investment, collateral management and price discovery are all done on chain in what the crypto world refers to as a “trustless” manner – where there is no single governing entity and participants don’t have to just trust one another. The risk management side of things meanwhile is done off chain.
This introduces credit into the crypto economy, Sit said.
“Most protocols, you go to the protocol, you put your [asset] down, they give you incentive tokens, that’s how you get a yield,” Sit said. “With this model of the option vaults, we are creating your real yield, because we are introducing credit by taking on the risk from the protocol and managing the risk outside of Defi. This hybrid model introduces real yield and real credit.”
The option vaults also help remove some front-running issues because price discovery is done in a more traditional manner, Sit said. Front running is when market-makers deal on information before their clients can see it.
The team has predominantly focused on centralized finance for crypto options, but when they were approached by Ribbon, a protocol that offers crypto structured products, they saw an opportunity with DeFi options.
Q4 outlook
Volatility, by crypto’s standards, has been weaker in the past month or so, with a major bull rally underway. Both bitcoin and ether hit new all-time highs in the past week, while many of the smaller alt-coins have doubled or even tripled in value in the blink of an eye this year.
Only Wednesday’s US CPI inflation numbers delivered a hit to the otherwise buoyant crypto market, knocking bitcoin (BTC) and ether (ETH) off record highs to around $65,500 and $4,700, respectively.
Crypto is known to have strong seasonality with the fourth quarter of the year. Nursey is seeing this reflected in the option flows, where they’ve paid consistently for topside options for this period long before the quarter started.
“Any sort of statistical conclusions you want to draw from our data [around seasonality is] going to be naturally flawed,” Nursery said. “But there’s no doubt that there’s a lot of fundamentally good news out at the moment.”
With strong institutional interest coming in, combined with genuine improvements taking place in many of these new coins, the market is looking very bullish, Nursey said.
But there are always risks lurking.
“You cannot ignore how leveraged the market is, you are trading in the market that is not regulated , exchanges offer anywhere from 20x to 100x margin on the futures trading, book trading,” Sit said. “We are in a very, very leveraged market.”
Another big elephant in the room is
Federal Reserve
tapering, Sit said. A lot of growth in the crypto markets has been driven by cheap money, but he asks, what happens if it stops being so cheap?
“I guarantee that will have any effect on crypto,” Sit said.”We are very close Fed watchers for a reason and we make a lot of views based on what we think the Fed might or might not do in the market reaction to that. To me, that is one huge risk where action from the Fed could cause contraction and cause a deleveraging cycle.
“And a deleveraging cycle in crypto is always pretty nasty.”
As the team runs one of the biggest option books, they have to maintain a directional view, Sit said.
In a November 10 note, they highlighted they expect broad bullishness to perpetuate in the near-term. In terms of how they’re positioned, they are currently short vega – how sensitive an option is to implied volatility – in ether and long vega in a number of alt-coins, including solana, dogecoin, cardano and polkadot. They remain overall short vega and long spot across the board.
