Traders say options liquidity dried up in equities and crypto, but different forces were at play

The spread of coronavirus and its economic fallout has sent shockwaves across Wall Street, forcing exchanges to shut their historic trading floors and brokers to work remotely. 

Indeed, the impact of remote work has presented unique problems relative to past crises, including compliance headaches, the inability to price assets, and, of course, liquidity issues. Bloomberg News reported this past weekend that the closure of derivatives exchange trading floors, specifically, has diverted liquidity away from certain options markets in products tied to the S&P500, citing Peak6 Investments.

"If you're a broker, you have access to tons of liquidity providers in the pit. Now, that doesn't exist anymore," Neel Shah, a trader at Peak6, told Bloomberg. "All those brokers are upstairs, and to call up 10 people is going to take longer to source that liquidity."

Bloomberg cited the difference between open interest in the SPY ETF and put options on the S&P500 as an example of illiquidity tied to the closure of CME Group's floor. This is the longest period CME's trading pit has been closed in its history, according to a spokeswoman. CME took issue with Bloomberg's piece, noting in a statement:

"Though liquidity does shift in times of extreme volatility, market participants continue to manage their risk in our S&P 500 options productsWith block and electronic trading available, S&P 500 options that traditionally have been trading on the floor have averaged 10,500 contracts per day on the screen since March 13. Further, since that time, all S&P 500 options on CME Globex have averaged 859,000 in volume per day, a 36% increase over 2019.” 

In any case, limited liquidity and the divergence between assets tied to the same underlying product should not come as a surprise, given the fact that periods of steep volatility often result in less liquidity. 

Indeed, liquidity issues have also plagued crypto options markets, according to several traders who spoke with The Block. Volumes, which can correlate with liquidity, dropped precipitously following the March 12-13 price crash, as shown by data from Skew. 

Liquidity indicates the ease at which traders can enter into a position whereas volumes measure the number of transactions taking place in a market. 

Volumes fell from a 6-month peak above $300 million in mid-March to just over $20 million on Tuesday. Open interest in bitcoin options also decreased, falling from over $700 million on March 26 to over $550 million on Tuesday. 

At CME, bitcoin options volumes have also taken a nose dive, falling from a 2020 high of $5.4 million on January 17 to just over $600,000 on Tuesday. Still, the firm reported strong overall growth in its bitcoin derivatives products, according to Tim McCourt, CME's global of equity index and alternative investment products. 

“While liquidity can shift during times of heightened volatility, clients managed their bitcoin price risk in increasing numbers at CME Group during the first quarter of 2020," he said. "For example, average daily volume in Bitcoin futures grew 116 percent to 9,427 contracts, equivalent to 47,135 bitcoin, during Q1."

Traders say that liquidity dried up in the crypto options market mainly because certain market makers – brokers who quote prices for investors – went into retreat.

"Crypto option liquidity has suffered as well," noted QCP Capital's Darius Sit. 

In some cases, they retreated because of the heavy losses incurred on March 12, when bitcoin fell by more than $3,000 in less than a 24-hour period. In other cases, some retreated because they operate across different asset classes and have bigger fish to fry outside of the crypto world.

Further fueling to the lack of liquidity is the fact that market-makers have widened spreads to take in more profit to accommodate for the added risk of staying in the market during a period of heightened volatility.

"Most of the liquidity is provided by a small group of players," Richard Rosenblum, founder of options trading shop GSR, said in an interview. "When one goes back to focus on traditional access, or gets hurt by the market move, they widen out their crypto markets, or shut the machines off altogether."

Still, Luuk Strijers, COO of options exchange Deribit, said that liquidity has started to pick back up since the March quarterly expiry. 

"We have actually seen options open interest growing again from USD 350m to USD 500m," he said. "Also our September futures are in contango again slowly attracting new OI. Overall volumes are a bit lower due to relatively lower volatility."

This post was edited for clarity and to include a statement from CME Group.