Bitcoin Indicator Suggests Potential for Leverage Washout

• A key indicator based on bitcoin futures and options suggests outsized levels of leverage in the market and the potential for leverage flushout.
• Bitcoin has been restricted to a narrow range in recent weeks, awaiting a breakout.

A bitcoin (BTC) indicator is suggesting a build-up of speculative froth in the market, often a recipe for leverage flushout and a sudden drop in price.

The ratio between the implied yield basis, or annualized spread between prices for one-month futures and prices in spot markets, and options-induced one-month implied – or expected – volatility has more than doubled to around 0.34 this year, according to data tracked by crypto structuring and trading solutions firm STS Digital.

"When the implied yield basis is large relative to the underlying volatility, it can signify outsized levels of leverage and speculation," Jeff Anderson, a senior trader at STS Digital, told CoinDesk.

Excess bullish speculation often leads to leverage washout, or forced closure of leverage positions due to margin shortage. The so-called long liquidations can end up fueling a sharp price slide.

"The market appears to be positioned for a move higher, which is all the more interesting when considering that the flows in spot have been leading the market post-ETF introduction (and thus implying that the spread could tighten)," Anderson added.

Bitcoin has rallied nearly 22% to $51,500 this year, mainly on the back of strong uptake for the U.S.-based spot exchange-traded funds (ETFs), approved last month. Inflows, however, slowed last week, with 10 ETFs attracting just 500 BTC on Wednesday.

Previous instances of futures basis trading at extremes relative to options-induced volatility, observed in the third and final quarters of 2023, were followed by bigger daily price fluctuations, as prop trader Julien noted on X.

Still, some other indicators remain bullish. CoinDesk Indices' Bitcoin Trend Indicator, which measures the price trend of bitcoin, has signaled a "significant uptrend" for the past 26 days, indicating upward trends in all four of the look-back periods the signal observes.

"While the Bitcoin Trend Indicator is currently showing a strong uptrend, we could see the signal change quickly if the recent consolidation of bitcoin's price persists," said Andy Baehr, head of product at CoinDesk Indices.

Awaiting range breakout

Bitcoin has traded between $50,500 and $53,500 in recent weeks. Markets build energy during such consolidations, eventually breaking out to produce large moves in either direction.

"BTC is currently in a negative gamma profile range, but spot prices seem to be stuck between the $50k-$52k range, we really need to see a move out of there for any momentum to come in," Greg Magadini, head of derivatives at Amberdata, said in the weekly newsletter.

A negative gamma situation is one where options market makers trade in the direction of the price – buy high and sell low – bolstering the trend.

UPDATE (Feb. 26, 16:05 UTC): Adds CoinDesk Indices' Bitcoin Trend Indicator in eighth paragraph, quote in ninth.