Crypto Markets Daily Nov 27 2024

Temporary Set Back, ETH Basis, and Microstrategy Convertible Notes

The post-election “up-only” rally in crypto seemingly hit a roadblock this morning – although we note that the real bearish positioning in options markets was limited to short tenor options, and even then the skew looked bearish because of (we speculate protective) put-buying, rather than unwinding of bullish call positioning. That fact was supported by stubbornly positive funding rates and levels of open interest in perps markets.

However, the impact of the pullback over the last 24H does not show up in the same open interest data as strongly, and while the move looks particularly drastic for short-term expiries, anything longer-dated than 2 weeks remains stubbornly bullish.

That backs what we have seen in ETF inflows too – yesterday, Bitcoin Spot ETFs saw outflows of $122.8M, continuing from the Monday outflows, while ETH Spot ETFs on the other hand recorded net inflows of $40.6M – marking the third consecutive trading day of inflows.

We’ve been tracking ETH’s outperformance against BTC since the election – and highlighted in this daily comment initial signs of the move being sustained. Two days on, it appears ETH is still outperforming. We’re also seeing futures yields in ETH overtake BTC’s. If, as has been speculated, institutions looking to capture the so-called “basis” by selling CME futures and buying spot BTC via the ETFs are to blame for some of the incredibly large inflows, then we could see similar happen in ETH over the next week if its yields continue to offer a larger basis than BTC’s.

But we don’t need to look too far for narratives that are driving the ETH outperformance narrative. On top of Gensler’s exit announcement, on-chain activity on Ethereum indicates demand for blob space has remained elevated, highlighting growing Layer 2 transaction volume (and fee generation for staked ETH holders).

We noted that Michael Saylor’s Microstrategy plans to increase its bitcoin exposure to nearly 2% of the supply – but we didn’t tell you how the company is funding the acquisitions: convertible notes (basically selling options on MSTR stock). Here is our best effort to break down the options embedded in the note – without providing explicit pricing for any of the trickier bits.

Technically, the investors used the interest they would have earned on the cash lent to purchase optionality on MSTR. Unfortunately, instead of a vanilla condition that the note allows the investor to purchase MSTR shares at a pre-agreed strike price at a pre-agreed expiry, the note has two more conditions that make it harder to value the optionality:

• The investors hold an American call option to convert and buy MSTR shares before June 1, 2029, at a strike price of 1.3x the current price.
• The note is callable (redeemable) by MicroStrategy on or after December 4, 2026, if the share price reaches 1.3x the conversion price

Therefore, far from a simple 5-year call option with a 1.3x strike, the structure is more like an American call spread (with mismatched start and expiry dates) with strikes of 1.3x vs. 2.015x the current price that “knocks-out” if the underlying spot price breaches the upper strike.

This means that if MSTR is trading at above 2.015x the current price after Dec 4, 2025, MSTR has the option to redeem the note and repay the investors in cash. Essentially that means that MSTR holds an American option from that date onward to redeem the bond while effectively paying no interest on the borrowed cash. Furthermore, if MSTR doesn’t redeem the full amount, the maximum they can redeem is the amount borrowed minus $75 million.

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