Earlier today, Bitcoin (BTC) price peaked at $18,476 after an impressive 35% bull run that appears to have started in early September.
This powerful movement was followed by a correction to $17,000, a natural pullback. This adjustment led some investors to question whether the current formation resembles the $13,850 top formed in July 2019.
BTC/USD, July 2019. Source: TradingView
Back then, a 30% drop followed a similar-sized rally, and afterwards it took Bitcoin 14 months to regain the $13,850 level. Coincidently, an intense flash crash happened right after that local high, but the price eventually recovered and stabilized near $12,800.
If something similar happened this time around, investors would expect a $13,000 low for the current cycle. Apart from a flash crash following a strong rally, what other indicators mimic the July 2019 price action?
The first step is to analyze the futures basis indicator, which can be interpreted as investor optimism. Basis is also frequently referred to as the futures premium, and it measures the premium of longer-term futures contracts to the current spot (traditional markets) levels.
Fixed-month futures contracts usually trade at a slight premium, indicating that sellers request more money to withhold settlement longer. On healthy markets, futures should trade at a 5% or more annualized premium, otherwise known as contango.
Bitcoin 3-month futures annualized basis, July 2019. Source: Skew
Some excessive optimism might have taken place as the basis indicator touched 20% on June 23. Nevertheless, it sustained very healthy levels through the entire price correction back in 2019.
The above chart can be interpreted as an absolute unwillingness to reduce long positions. This movement happened despite a $2,000 flash crash followed by a 30% correction from the top.
Oddly enough, not even the 30% crash that followed the $13,850 top reduced the futures contract premium. Reduced bullishness usually has a massive impact on the basis indicator.
Fast-forward to the current scenario, and there isn’t a single instance of excessive optimism according to the same metric.
Bitcoin 3-month futures annualized basis, November 2020. Source: Skew
The above chart shows the basis indicator quickly falling below 10% right after the $18,500 top formation. To further differentiate the current price action from July 2019, two weeks ahead of the price peak the futures premium stood at 0%, a clear indication that investors were feeling bearish.
This time around, the lowest level over the past couple of weeks has been 7%. This means investors have kept positive expectations over the past couple of months, whereas in July 2019, the market faced an intense, quick, optimistic rush.
Options traders weren’t so bullish ahead of the pump
To better assess the current market sentiment, investors should also evaluate options market spreads. The 25% delta skew indicator will shift to negative when call (neutral/bullish) options are more costly than equivalent put options. The metric usually oscillates between -20% to +20%, and it reflects the current market sentiment.
Bitcoin 3-month options 25% delta skew, June 2019. Source: Skew
Oddly enough, Bitcoin underwent an 80% bull run in the three weeks preceding the $13,850 top, but the options market seemed ill-prepared for this. At the time, protection for the upside using call options were trading at the same premium as the bearish puts.
Therefore, we can conclude that option traders were pricing in the same probability of a strong market swing in either direction. This situation has not been the case recently, as the 25% delta skew indicator shows.
Bitcoin 3-month options 25% delta skew, November 2020. Source: Skew
For the past 30 days, this option market sentiment gauge has been signaling bullishness. Traders are unwilling to sell protection for the upside, thereby causing the skew indicator to reach an unprecedented -30%.
As professional traders are demanding a sizable premium for bullish call options, one can only conclude that a sudden price dump is far away from their expectations.
Investors should not make decisions solely based on the interpretation of a single indicator that shows option traders are overly bullish right now. These traders could have been taken by surprise and therefore are not eager to open short positions.
There are substantial differences between July 2019 top and the current market according to futures and options markets. This indicates that there are no signs that a 30% drop will occur over the next few days.