Delta Hedging Bitcoin Options with a Smile

We analyse robust dynamic delta hedging of bitcoin options using a set of smile-implied and other smile-adjusted deltas that are either model-free, in the sense that they are the same for every scale-invariant stochastic and/or local volatility model, or they are based on simple regime-dependent parameterisations of local volatility. These deltas are popular with option market makers in traditional assets because they are very easy to implement. Previous empirical research on dynamic delta hedging is based solely on equity index options, but analysis of our unique data set of hourly historical bitcoin option prices reveals that the bitcoin implied volatility curve behaves very differently from that of equity index options. We show that about 80\% of trading activity is on bitcoin options with expiry less than four weeks, and hence we only focus on those options in this study. For call and put options with a wide range of moneyness and with synthetic constant maturities of 10, 20 and 30 days, we compare the dynamic hedging performance of different smile-adjusted deltas over two one-year periods. We also examine the use of the perpetual contract rather than the standard futures as hedging instrument. Results are presented as testable statistics of hedging error variance ratios. In certain periods the use of smile-implied hedge ratios can significantly out-perform the simple Black-Scholes delta hedge, especially when using the perpetual swap as hedging instrument, where efficiency gains can exceed 30\% for out-of-the-money puts, and reach an average of 15\% when hedging short-term out-of-the money calls during periods when the implied volatility curve slopes upwards. The advantage of using the perpetual contract is especially evident during 2021, for the longer-term contracts for which the basis is still rather large.