Market Update

Markets are abuzz with BTC up 16% since the start of the week. The market is hopeful Q4 this year will repeat the 180% rally we saw in Q4 last year (Chart 1).

Chart 1 

The speed and size of the move has been surprising and was clearly caused by a short squeeze (liquidation of leveraged short positions). We highlighted this possibility on Tuesday (see previous Market Alert above) as we observed an unusual divergence in perp funding rates. DYDX perps had positive funding at extremes of up to over 100% (Chart 2) while the Chinese exchanges had negative funding rates.

Chart 2 

And sure enough, a large portion of the liquidations occurred on Chinese exchanges yesterday (Chart 3).

Chart 3 

At the same time, we suspect that institutional demand has been the underlying driver of this move higher. Two reasons suggest this:

1. There has been a significant increase in CME Bitcoin Futures Open Interest (Chart 4) which is the main avenue for institutional exposure to BTC.

Chart 4 

2. The premium (vs spot) of the CME futures has been the highest among the major exchanges (Chart 5). This is noteworthy as the CME futures premiums are typically compressed due to the cash-and-carry spread trades that institutional players like to put on (buy spot vs sell CME future). The unusually large premium indicates an overwhelming amount of outright buying.

Chart 5

Both factors combined lead us to believe that there has been large institutional buying of BTC in the past week.

The GOLDEN question is whether Q4 2021 will see upside in the same magnitude of Q4 2020.

There are many reasons to be bullish; the stabilisation of the Evergrande situation, possible upcoming approvals for BTC ETFs in the US, more traditional finance stalwarts like Soros Fund Management turning crypto-positive.

While we are optimistic, we do have some reasons to doubt a similar exponential move:

a. There is a lot more leverage in the market than last year. Open Interest (OI) is more than triple (Chart 6). In fact, BTC OI is reaching levels that tend to precede market sell-offs. We will start to be cautious of potential downside risk if OI levels continue spiking.

Chart 6

b. The options market continues to indicate downside nervousness in spite of the spot rally. ETH risk reversals (RR) continue to be skewed to the downside (puts are more expensive than calls). BTC has only just turned from a persistent downside skew to neutral.

On the desk, we also continue to see bearish-type trades with the spot rally. A total of 1,200x BTC end-October BTC calls were sold yesterday, followed by the buying of over 500x of 50/45k end-October put spread today.

In the very short-term, we might see some corrective price action in BTC. The daily chart had a Tom Demark (TD) Sequential 9-9-13 sell signal yesterday (Chart 7) and the two-day chart will also have a TD 13 sell signal at today’s close. To add to this, tomorrow is likely to see the daily chart complete a TD 9 sell signal as well.

Chart 7

Position-wise, we ended last week fairly nimble. At the start of the week, we bought gamma in BTC (particularly long 52k calls in 1-week BTC calls from Defi options) against selling gamma in ETH . We scaled up the size of this trade as we expected some large moves in BTC from the funding divergence discussed above. This trade has worked out extremely well with BTC spot moving much more than ETH.

Vols have naturally spiked on the gap higher and we took the opportunity to sell vega (particularly in the December-March bucket). We think vol levels have found a top here. Levels have already started to fall sharply with BTC trading sideways today.

Our view is that BTC continues to be the headline mover in the next few days. We are keeping long gamma in BTC, BCH, DOGE ALGO, LUNA, SOL ADA (new!) vs short gamma in ETH. And we are short vega in BTC and ETH against long vega in BCH, DOGE, ALGO, LUNA, ADA.