Opinion Bitcoin traders are concerned about tail risk.

Bitcoin traders worry about tail risk.

Author: Omkar Godbole, CoinDesk; Translation: Song Xue, LianGuai

  • Bitcoin-related out-of-the-money (OTM) call and put options are relatively abundant, indicating that traders are pricing in the “tail risk” of the Bitcoin market.

  • Tail risk refers to the higher probability of investment deviating from the average value by more than three standard deviations.

They call it the tail risk of the cryptocurrency market: the risk of the current price of an asset deviating three standard deviations from the average in the context of rare events.

Traders are concerned that Bitcoin (BTC) will experience such an event, despite hovering around $26,000 since falling more than 10% in a week ending on August 20. According to Amberdata, Bitcoin’s 7-day historical or realized annualized volatility has dropped from nearly 60% earlier last week to 26%.

Griffin Ardern, a volatility trader at cryptocurrency asset management company Blofin, said: “Bitcoin’s butterfly index has risen to a yearly high. This indicates that investors and market makers are pricing in tail risk.”

The butterfly index measures the relative abundance of out-of-the-money (OTM) call and put options by comparing the Bitcoin volatility index (DVOL) and the at-the-money (ATM) volatility of the cryptocurrency exchange Deribit.

An increase in the index indicates relatively strong demand for OTM call options or call options with strike prices higher than the current price of BTC, while put options have strike prices lower than the current market price of BTC. In other words, it indicates traders’ fear of tail risk or sensitivity to uncertainty.

A call option is a derivative contract that gives the buyer the right to buy the underlying asset at a predetermined price later on. A put option grants the right to sell. Call option buyers are implicitly bullish on the market, while put option buyers are bearish. Demand for OTM call and put options increases when traders expect prices to trend above average levels.

“By observing the BTC butterfly index, we can see that the percentile of the wings is close to 90% (red horizontal line). Therefore, although direct volatility [indicators] seem confident in the consolidation of spot prices, traders are still paying a price for the tail,” said Greg Magadini, Derivatives Director at Amberdata, in a weekly newsletter.

The butterfly index remains high, indicating persistent concerns about significant fluctuations in Bitcoin prices. (Amberdata)

The index is calculated as the ratio or spread between the Bitcoin volatility index (DVOL) of the cryptocurrency exchange Deribit and the at-the-money (ATM) volatility. Deribit’s DVOL considers the pricing of all options, while the ATM tool is based on the pricing of at-the-money options.

The pricing of tail risks is consistent with persistent macroeconomic uncertainty.

On Friday, Federal Reserve Chairman Jerome Powell reiterated that the central bank remains committed to achieving and maintaining a 2% inflation target, while also suggesting that monetary policy will remain tight for longer than expected.

The continued tightening bias of the Federal Reserve has pushed bond yields to their highest level since 2007. Rising bond yields often put pressure on risk assets, including cryptocurrencies.

Maggie Madani pointed out, “An important insight from Jerome Powell is that ‘getting inflation back to 2% may require growth lower than trend,’ which means that he is not worried about the economy and the labor market taking a hit.”

Ardern said, tail risks may still be higher before the release of the US nonfarm payrolls report on Friday. According to the Wall Street Journal, the data may show that the US economy added 200,000 jobs last month, following an increase of 209,000 jobs in June, keeping the unemployment rate stable at 3.6%.