One important thing that anyone tracking Bitcoin will notice is how market sentiment can seemingly change in a matter of moments. We’re an Elon Musk tweet away from a bear market, a Tesla earnings report from a huge bull market. It’s about as emotional of a market as you will ever find it. The question is: what metrics can we use to quantify where we are on this emotional spectrum?
One thing I like to keep track of is the relationship between calls and puts in a given month, let’s call it the “return versus volatility ratio”. Basically, it takes into account the distance between calls and puts with the same price from the current price of spot bitcoin and divides the price difference between the calls and the spot bitcoin price by the price between the puts and the spot bitcoin price. How high or low this metric is is determined by many things, but primarily the implied volatility of the options skew and the futures yield curve – which gives the metric its name. This ratio can give a very good idea of how the market is currently forecasting the price of Bitcoin. What is the mood? Bitcoin is close to the moon? Or is the run over and we should prepare for a three-year bear run?
The best way to illustrate this is with a few examples from the past few months. On May 11, 2021, with a Bitcoin spot price of $ 55,000, let’s look at the ratio for September 24, 2021, when the Deribit expires:
The $ 50,000 put traded at the same price as the $ 80,000 call. This means that the put strike was USD 5,000 away from the spot bitcoin price, while the call strike was USD 25,000 away from the spot bitcoin price. If we divide the difference in the call strike of spot bitcoin ($ 25,000) by the difference in the put strike ($ 5,000), we see that the ratio is 5: 1.
Five to one is a very high score on this metric. As you may recall, Bitcoin was in full bull market mode back then. One trading idea that you could use to take advantage of these market conditions would be this:
+ Bitcoin at $ 55,000
+50,000 put
-80,000 call
Zero cost
If you trade with this strategy, you will have the following bitcoin exposure until the options expire:
On the flip side, you are long at $ 55,000 but can only lose money until the put strike of $ 50,000, where your losses will stop meaning you can lose up to $ 5,000. On the other hand, you will profit until you reach the price level of $ 80,000, where you are limited to a profit of $ 25,000. This means you can make a profit of $ 25,000 (45% higher) while only risking $ 5,000 (9%) in potential losses. Notice again the ratio of 5: 1.
I like these odds. Given that I am overall long-term optimistic about Bitcoin, it can be difficult to find suitable ways to hedge your long-term exposure as I generally don’t like selling spot Bitcoin. However, when we see the call / put ratio hitting a level of 5: 1, I want to hedge a percentage of my total exposure by selling calls and buying puts.
In contrast, just over a month later, on June 21, 2021, you could interpolate the ratio for the July 30, 2021 expiration with the following inputs: If the Bitcoin spot price was $ 36,000, the puts would be $ 32,000 the price of the. equals $ 41,000 in calls. The ratio is 1.25: 1.
What would a trading idea be in this market? I like to do the opposite of the above recommendation. This time it is worthwhile to just buy the calls and sell the puts. Think about it, in purely mathematical terms, the maximum you can lose on the puts is $ 32,000 – assuming BTC goes all the way down to $ 0. But the benefit is unlimited. Given Bitcoin and its ability to go parabolic, it doesn’t make sense for this ratio to approach 1: 1.
What is the current relationship like? As yields have risen lately on the recent rally, the ratio has increased, especially as time moves further away. On August 24, the ratio for the expiry on December 31 is 2.80: 1. (Note: this is an approximation as it can vary depending on which first call or put strike you choose. For consistency, I like to choose a put that is about 10% lower than the spot and then redeem the call.) has bounced back from its recent lows, but is likely to have even more expansion potential in the months ahead, especially as higher yields return to the futures market. Selling a portion of the ratio by selling calls or buying puts is not a bad idea. But I would do this sparingly as the odds are that the ratio will continue to rise to a higher level.
Most importantly, you can control your own emotions, although the metric indicates where we are at any given moment on the emotional spectrum. It’s important to keep your cool with all of this and play the hand the market has given you.
This is a guest post by Patrick Baker. The opinions expressed are solely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.
