Rising Bull and Raging Bear in Bitcoin

7 февр. 2023 г.

Newton is known to have said that "The motion of heavenly bodies can be computed, but not the madness of people". That aptly fits the times we live in.

Bitcoin (“BTC”) prices have rallied 40% since the start of the year despite bleak economic outlook. A short squeeze in the flagship crypto asset where 850M in short positions was liquidated in just three days is cited as the primary reason for the rally. After the US Fed, ECB, and BoE rate announcements last week, where does BTC go from here?

There are ample reasons to remain bearish as much as there is to turn bullish. Are we witnessing a dead cat bounce? Or is this the dawn of a new era where rates flatten or start to soften paving the path to a bull run?



Amid the chaos, one thing remains clear. Low volatility. Both realized and implied volatility for BTC remains low. In a market that could either crumble or rally, this case study argues that a long strangle position in BTC options provides a compelling >2x reward to risk ratio. A long options position gains not only from a substantial price move but also from expanding volatility.



THE UNCERTAIN ROAD AHEAD FOR BTC

Outlook for BTC prices looks uncertain. Bullish tailwinds and bearish restrainers are concurrently at play.

1. Mixed Technical Signals

BTC is approaching its 200-day moving average which has served as strong resistance in 2022. During the previous bear market rally, prices failed to breach past $25,000 per BTC, indicating strong resistance at this level. Current RSI at 79 points to BTC being overbought with a risk of downward price correction.

However, the 20-day moving average inching towards the 200-day moving average might create the settings for a price rally.



Also, the 10-day MA has crossed over the 200-day MA, forming a golden crossover which might be a harbinger of rally ahead.



Using this same chart, we highlighted before that BTC prices are now just below the long-term MA (200-week MA) that has proven to be a strong indication for a long-term trend. The divergence from this trend over the past half-year might have been aberrations caused by multiple black swan events.

2. Price volatility related to GBTC lawsuit outcome

Also as mentioned previously, Grayscale’s lawsuit against the SEC is an event to watch. Hearing date has been set for March 7th.

If unsuccessful, Grayscale has announced plans to liquidate a portion of the trust to bring the GBTC shares back up to NAV of its holdings. This would involve heavy BTC selling pressure. GBTC has 14.5B in AUM with GBTC shares trading at a 41% discount.

If GBTC succeeds, BTC prices could rally in sign of favorable regulatory acceptance. However, ETF’s creation/redemption mechanism would allow GBTC to rebalance their holdings resulting in spot BTC sales to arbitrage the discount.

3. Long term holders showing resilience and not selling

Recent price rally has restrained long term holders from dumping their holdings. Growing number of long-term holders indicates conviction and that combined with climbing retail participation sets the tone for a bull run.



4. Hash Rate Rebound in 2023

BTC mining is profitable again. Rebounding hash rates, stable energy costs, and elevated BTC prices is a relief to the miners. Miner reserves are at a yearly low removing the risk of miners dumping their inventory. Miner sales are now limited to BTC mined daily.



5. Growing Open Interest but mixed directional positioning

Asset managers have increased their net long positions by 53% between December 27th and January 24th. Meanwhile, leveraged funds continue to remain net short during this period. Clearly institutional investors remain puzzled on BTC price outlook.

In a sign of growing investor attention, overall OI is up 8.4% over the last month and nearly 20% over the last quarter

TRADE SET UP



With adequate arguments both in favor of and against BTC prices, establishing a directional position is difficult. BTC carries a reputation for triple-digit volatility over its 14 years trading history. Intriguingly, BTC volatility has been soft in the recent past. Low volatility allows investors to acquire options at reduced costs.

Being price agnostic, this study makes a case for a delta-neutral long strangle to secure a 2.27 reward to risk ratio.

A long strangle combines of two trades. One, an out-of-the-money long put (at a strike below the current bitcoin price) to gain from a falling market. Two, an out-of-the-money long call (at a strike above the current bitcoin price) to gain from a rising market.

A strangle allows the holder to extract an outsized gain (profit) for every unit of pain (costs incurred for premiums). This asymmetric pay-off in an options portfolio is referred to as convexity in finance. It enables holders to extract higher rewards for each unit of risk.

Leg 1: Long Put options on BTCK3 (options on futures expiring in May 2023) with a strike price of $21,000 at a premium of $1,635.
Leg 2: Long Call options on BTCK3 (options on futures expiring in May 2023) with a strike price of $29,000 at a premium of $1,105.

Entry: $2,740
Break-even points: When CME-BTC-Futures touches $30,740 or $18,260.
Target: BTC at either $33,600 or $13,700
Profit at Target: $1,860 (if BTC rises to $33,600) or $ 4,560 (if BTC drops to $13,700)
Stop-loss level: At 30% of the drop in options premium.
Loss at Stop-loss: $820

This strategy will start generating returns when the underling future trades past break-even points. It will also generate returns as volatillity expands fueling increase in strangle value.

MARKET DATA

CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/gopro/

DISCLAIMER

Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.

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