De-risking Sentiment, High Volatility, Low Confidence, Winding Down Shorts - -The Derivatives Market Tells Us a Detailed Story.
(March 15th 2020 by TokenInsight Research)
Authors: Johnson Xu, Harper Li
Email: johnson@tokeninsight.com
Overview
Derivatives such as futures and options can deliver insightful data that can be used as a proxy to forecast the market in advance and reflecting overall market sentiment.
Bitcoin plummeted as the cryptocurrency market experienced a market-wide panic alongside a significant liquidity crunch on the buy-side order book, back down to $5K from $7K range, the market continued its strong downside movement and briefly touched sub $4K and rebounded sharply to $6K, wiped off more than $90 billion in value at the lowest market point. Over the past week, we have seen both the equity and cryptocurrency market tumbles sharply. At the time of writing this analysis piece, Bitcoin is hovering around the $5K range.
Market Outlook Summary
· The market is now pricing in a probability of BTC> $7.5 (Returning to the pre-crashed price level) by March 2020 at only 13%, by June 2020 or September 2020 at roughly 23%. (March 14th 2020)
· Pricing in a probability of BTC> $10K by Sep 2020 at only 12% (March 14th 2020).
· Implied volatility (IV) trending up, reflecting significant increases of volatility in the market.
· The at-the-money (ATM) Implied volatility shows an inverted structure, indicating the market perceives BTC is in a de-risking sentiment.
· A stronger de-risking sentiment has been presented in the market in the short term by looking at different terms of ATM IV.
· Perpetual swaps funding is still in the negative territories but reversing to the 0 baselines, reflecting the market is still encouraging shorts to wind down the positions.
· Falling prices in a downtrend while open interest is declining which indicates some holders are forced to liquidate positions and is in a short-term bearish territory.
Options Market
Implied volatility (IV) as one of the most important indicators in the options market, it represents a forecast of a likely movement in the bitcoin’s price. The IV directly impact on the price of the options, high IV results in higher premiums and vice versa.
We collect the following options data from Deribit on March 11th 2020, which including a number of options volatility curves with different maturity periods for March 2020, plotted the IV against the strike prices, as we can see in figure 1. The volatility skew pattern is known as the reverse skew or volatility smirk. Under the volatility smirk pattern, the IV for options at the lower strikes are higher than the IV at higher strikes, it suggests that on March 11th 2020, in the money (ITM) calls and out of the money (OTM) puts are more expensive compared to out of the money (OTM)calls and in the money (ITM) puts.
One of the popular explanations for the reverse skew pattern is that generally speaking investors are worried about market crashes and thus buying puts for protection and driving the premium up.
The longer-term volatility skew pattern has also been plotted (Figure 2), showing a reasonable pattern of a volatility smirk and are consistent across three different maturities.
We collected the options data again on March 13th 2020. The patterns have changed significantly, with IV of near term options such as 0314 & 0320 ranging from more than 250% to 500%. The randomness and high IV values for 0320 show that the market is in an extreme uncertain stage coupled with extremely high volatility. All three March options’ IV spiked significantly compared to just 2 days ago.
The IV for longer-term options data collected on March 13th 2020 also spiked significantly, 0424 options shows a possible forward skew pattern where 0626 and 0925 options data exhibits a volatility smirk.
The market is now pricing in a probability of BTC> $10K by Sep 2020 at only 12%, it is also pricing the probability of BTC> $7.5 (Returning to the pre-crashed price level) by March 2020 at only 13%, by June 2020 or September 2020 at roughly 23%, demonstrates the market has low confidence in the short term (i.e, By March 2020).
IV spiked significantly on heavy trading when the market sell-off just started, started to drop abruptly in roughly an hour and continued its downtrend within the 6-hour window, then the IV started trending up again, reflecting significant increases of volatility in the market.
IV is not constant across different maturities, which means that options with the same strike price, but different maturity can have different IVs. This determines the term structure of volatility, which is contango under normal condition, meaning the IV for longer-term options are higher than the short term ones. When markets are in stress and de-risking sentiment prevails, market participants demand short term options and thus pushing their prices and causing the term structure of volatility to invert.
In this case, prior to the market crash, BTC ATM IV indicates a contango market condition. However with price moved to downside significantly, its ATM IV structure inverted, indicating the market perceives BTC is in a de-risking sentiment. In addition, the gap between 1 month ATM IV & 3 months ATM IV is greater than the gap between 3 months & 6 months ATM IV, indicating a stronger de-risking sentiment has been presented in the market in the short term.
Futures Market
BTC perpetual swaps funding collapsed to the negative territories when the market sees a major sell-off to incentivise short positions to unwind. The current funding % is still in the negative territories but reversing to the 0 baselines, reflecting the market is still encouraging shorts to wind down the positions.
The futures market can also tell a story on the market condition. The above two figures show falling prices in a downtrend while open interest is declining which possibly indicates some holders are forced to liquidate positions and is in a short term bearish territory. The Bitmex BTC/USD liquidations data can also back the analysis which No. of liquidations increased significantly when the market began the sell-off.
Summary and Final Thoughts
The derivatives market data deliver an insightful picture of the current market state. Market participants should leverage these financial data to make an informed decision by analysing and interpreting the market data.
As current market condition indicated by the derivatives market, we believe it is still at de-risking sentiment, low confidence and high volatility stage. The market has not yet shaken off the panic state, and market liquidity has not yet been restored to a normal level.
As the market condition can change suddenly, we believe a well-structured risk management plan is the key to sustain in this extreme market condition. We must respect the market in the meantime be aware of the risks.
About TokenInsight
Founded in 2017, TokenInsight is a Leading Data & Tech Driven Blockchain Financial Institution. TokenInsight pioneered a complete blockchain industry classification system, covering more than 1,600 projects, releasing more than 300 rating reports, and conducting in-depth studies into 10 major industries.
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