Considering that derivatives markets are now playing a much bigger role in Bitcoin price fluctuations, it is becoming increasingly necessary to review some of the key metrics professional traders use to gauge activity in the markets.
While reviewing futures and options contracts can be quite complicated, the average retail trader can still benefit from knowing how to properly interpret the futures premium, funding rate, options skew and put-call ratio.
The futures premium measures how expensive longer-term futures contracts are to the current spot at traditional markets. It can be thought of as a relative reflection of investor optimism, and fixed-calendar futures tend to trade at a slight premium to regular spot exchanges.
The 2-month futures should trade with a 0.8% to 2.3% premium in healthy markets, and any number above this range denotes extreme optimism. Meanwhile, the lack of a futures premium indicates bearishness.
The past week was a roller coaster and the indicator reached 2% on Nov. 24 while Bitcoin price peaked at $19,434.
Even though the premium currently sits at 1.1%, what is more significant is that despite a 14% price drop, the indicator held above 0.8%. Generally, investors view this level as bullish, and today we can see that Bitcoin price secured a new high above $19,900.
Perpetual futures funding rate
Perpetual contracts, also known as inverse swaps, have an embedded rate usually charged every eight hours. Funding rates ensure there are no exchange risk imbalances. Even though both buyers and sellers open interest is matched at all times, leverage can vary.
When buyers (longs) are the ones demanding more leverage, the funding rate goes positive. Therefore, those buyers will be the ones paying up the fees. This issue holds especially true under bull run periods, when usually there's more demand for longs.
Sustainable rates above 2% per week translate to extreme optimism. This level is acceptable during market rallies but problematic if BTC price is sideways or in a downtrend.
In situations like these, high leverage from buyers presents the potential of large liquidations during surprise price drops.
Take notice how, despite the recent bull run, the weekly funding rate has managed to remain below 2%. This data indicates that although traders feel optimistic, buyers were not overleveraged. Similarly, during the $1,400 price drop on Nov. 26, the indicator held a healthy neutral level.
Unlike futures contracts, options are divided into two segments. Call (buy) options allow the buyer to acquire BTC at a fixed price on the expiry date. On the other hand, the seller of the instrument will be obliged to make the BTC sale.
The 25% delta skew compares side-by-side equivalent call (buy) and put (sell) options. If the protection for price upswings using call options is more costlier, the skew indicator shifts to the negative range. The opposite holds when investors are bearish, causing put options to trade at a premium, causing skew indicators to shift positively.
Oscillations between -15% (slightly bullish) to +15% (somewhat bearish) are typical and expected. It's very unusual for any market to remain flat or near zero most of the time.
Thus, traders should monitor more extreme situations as they may indicate that market makers are unwilling to take risks on either side.
The above chart shows that since Nov. 5, option traders are unwilling to take positions exposing themselves against an upside. Therefore, traders will deem this a very bullish situation.
Options put-call ratio
By measuring whether more activity is going through call (buy) options or put (sell) options, one can gauge the overall market sentiment. Generally speaking, call options are used for bullish strategies, whereas put options for bearish ones.
A 0.70 put-to-call ratio indicates that put options open interest lag the more bullish calls by 30% and is therefore bullish.
In contrast, a 1.20 indicator favors put options by 20%, which can be deemed bearish. One thing to note is that the indicator aggregates the entire BTC options market, including all calendar months.
In situations such as the one currently seen in the market, it’s only natural for investors to seek downside protection as BTC surpasses $19,000 even though the put/call ratio has been way below its 6-month average of 0.90. The current 0.64 level shows that there is a lack of pessimism from professional traders.
Overall these four key indicators have held steady, especially considering the market just suffered a somewhat traumatic pullback as BTC price dropped to retest $16,200.
With the price back above $19,500 again, nearly every investor wants to know if Bitcoin has enough strength to break its all-time high this week.
From a derivatives trading perspective, nothing is holding it back.