Anyone who is a Bitcoin follower will notice that market sentiment can change in a matter of seconds. One tweet away from a bearish market and one Tesla earnings report away is a bull market. This market is as emotional as any you’ll ever see. It begs the question: What metrics can we use to measure where we stand on this emotional spectrum.
One thing I keep track of is the ratio between calls and puts trading in a particular month. Let’s call this the “yield and volatility ratio”. It takes into account the distance between like-priced puts and calls from spot bitcoin’s current price. Then it divides the difference between calls and spot bitcoin prices by the price between puts and spot bitcoin. This metric’s value is affected by many factors, including the implied volatility of options skew and futures yield curve. This ratio can provide a good indication of the current market forecast for bitcoin’s price. What is the sentiment? Are bitcoins headed for the moon? Or are we in for a three year bear run?
This is best illustrated using examples from the last few months. On May 11, 2021, with the bitcoin spot price at $55,000, let’s look at what the ratio was for the September 24, 2021, expiration on Deribit:
The $50,000 put traded at the same price that the $80,000 call. The put strike was therefore $5,000 off the spot bitcoin price and the call strike $25,000 below the spot bitcoin. Divide the difference between the spot bitcoin price and the call strike ($25,000) by the difference between the put strike ($5,000) and we get a ratio of 5:1.
This metric gives a score of five to one, which is very high. You may recall that bitcoin was at its peak bull-market phase. To take advantage of these market conditions, you can use the following trade ideas:
This strategy would give you the following exposure to Bitcoin until your options expire:
You are short at $55,000 but you can only lose money up until the $50,000 put strike. Your losses are then stopped and you can lose as much as $5,000. You will make a profit up to the $80,000 price point, at which point you can only make $25,000 profit. This means that you can make $25,000 profit (45% more), and only risk $5,000 (9%) loss. You can see the 5:1 ratio again.
These odds are appealing to me. Because I am bullish on bitcoin for the long-term, it can be difficult to find ways to hedge your long term exposure. I don’t enjoy selling spot bitcoin and I tend to be long-term bullish on bitcoin overall. When the call/put ratio reaches levels of 5:1, I enjoy selling calls and buying put to hedge a portion of my overall exposure.
Compare that to the June 21st 2021 date. You could use the following inputs to interpolate the July 30th 2021 ratio: With the bitcoin spot price at $36,000 the $32,000 puts would be equal to the $41,000 calls. The ratio is now 1.25:1.
What trade idea would you have in this market? I prefer to do the opposite of what is suggested above. It is a good idea to buy calls and then sell the puts. You can only lose $32,000 on the put if you assume that BTC rises to $0. The upside is endless. It doesn’t make any sense to increase this ratio to 1:1, given bitcoin’s ability to go parabolic.
How does the current ratio look? The ratio has increased as we have seen yields rise on the most recent rally. This is especially true if you look further back in time. The December 31 expiry ratio is 2.80:1. This is only an approximate ratio and can change depending on the initial call you make or which put strike you take. To ensure consistency, I prefer to choose a put that is 10% lower than spot and then solve for the call. Although it has rebounded from its recent lows, there is still potential for expansion in the months ahead, particularly when futures markets offer higher yields. Selling calls or buying put is a good way to get rid of some of the ratio. However, I wouldn’t do it often as the ratio is likely to rise.
The most important thing is to be in control of your emotions. You must keep your head up and accept the hand dealt to you by the market.