This ratio creates a rise in the price of Bitcoin

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One important thing that anyone who follows Bitcoin notices is how market sentiment can seemingly change in a matter of moments. We are Elon Musk’s tweet from a bear market, Tesla earnings report from a huge bull market. This is about as emotional a market as you’ll 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 an eye on is the ratio of how the calls and puts are trading in a specific month, let’s call it the “return and volatility ratio”. Basically, it considers the distance between similarly priced calls and puts from the current spot bitcoin price and divides the price difference between calls and spot bitcoin price by the price between put options. and the price of bitcoin in cash. How high or low this measure is is determined by many factors, but primarily by the implied volatility of the asymmetry of options and the yield curve of futures contracts, which gave the measure its name. This ratio can give a very good idea of ​​how the market is currently forecasting the price of bitcoin. What’s the feeling? Is bitcoin about to go lunar? Or is the crash over and we should prepare for a three year bear race?

It is best to illustrate this using a few examples from the past few months. On May 11, 2021, with the spot price of bitcoin at $ 55,000, let’s take a look at what the ratio was for the September 24, 2021 expiration on Deribit:

The $ 50,000 put traded at the same price as the $ 80,000 call. This means that the sell strike was $ 5,000 off the bitcoin spot price, while the appeal strike was $ 25,000 off the bitcoin spot price. By dividing the difference between the call price and spot bitcoin ($ 25,000), by the difference between the sell price ($ 5,000), we see that the ratio is 5: 1.

Five to one is a very high score on this metric. As you may remember at the time, bitcoin was in the midst of a bull market. A business idea that you could use to take advantage of these market conditions would be to do the following:

+ Bitcoin at $ 55,000

+50,000 bets

-80,000 calls

Zero cost

By trading with this strategy, you would have the following bitcoin exposure until the options expire:

On the downside, you’re long at $ 55,000, but you can only lose money until the $ 50,000 strike, where your losses are halted, which means you can lose up to 5,000. $. On the upside, you will profit until you hit the $ 80,000 price point, where you are capped at $ 25,000 profit. This means that you can make a profit of $ 25,000 (45% higher), while risking only $ 5,000 (9%) in potential losses. Notice again, this ratio of 5: 1.

I like these odds. Since I’m broadly long-term bullish on bitcoin, it can be difficult to find suitable ways to hedge your long-term exposure as I generally don’t like to sell bitcoin for cash. However, when we see the call / put ratio reaching levels as high as 5: 1, I like to hedge a percentage of my overall exposure by selling calls and buying puts.

Compare that with a little over a month later on June 21, 2021, you can interpolate the ratio for the July 30, 2021 expiration using the following inputs: with the bitcoin spot price at $ 36,000, the $ 32,000 in sales would equal the price of 41,000 calls. This puts the ratio at 1.25: 1.

What would a business idea be in this market? I like to do the opposite of the above recommendation. This time it is better to buy the calls and sell the puts. Think about it, in purely mathematical terms, the maximum you can lose on put options is $ 32,000 – assuming BTC goes all the way up to $ 0. But the benefit is unlimited. Considering bitcoin and its ability to become parabolic, it doesn’t make sense for this ratio to approach 1: 1.

What does the ratio look like now? As we saw the yields rise recently in the last rally, the ratio has gone up, especially as you move forward in time. As of August 24, the ratio for the December 31 deadline was 2.80: 1. (Note: This is an approximation as it may vary depending on the initial or exercise purchase option you choose. For consistency, I like to select a purchase option of approximately 10% lower than the spot option, then resolve the call option.) Has rebounded from its recent lows, but probably has even more growth potential in the coming months, especially when higher yields start to rise. come back to the futures market. It is not the worst idea to sell part of the ratio by selling options or buying puts. But I would do this sparingly, as there is a good chance that we will continue to see the ratio increase to higher levels.

More importantly, although the metric is how far we are on the emotional spectrum at any given time, be sure to control your own emotions. It’s important to keep a cool head and play the hand the market has given you.

This is a guest article by Patrick Baker. The opinions expressed are entirely theirs and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

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