They call it tail risk in the crypto market: the risk of an asset moving three standard deviations from its current price due to a rare event.
Traders fear such an event for Bitcoin (BTC), even though the cryptocurrency has traded listlessly around $26,000 since falling over 10% in the week ended August 20. BTC’s seven-day annualized historical or realized volatility has cooled to 26% from nearly 60%. According to Amberdata seen earlier last week.
“Bitcoin’s Butterfly Index has surged to yearly highs. This shows that investors and market makers are pricing in tail risk,” said Griffin Ardern, volatility trader at crypto asset management firm Blofin.
The Butterfly Index measures the relative richness of higher-strike out-of-the-money (OTM) call options and lower-strike put options by comparing crypto exchange Deribit’s Bitcoin Volatility Index (DVOL) to at-the-money volatility (ATM) compares .
An elevated index indicates relatively stronger demand for OTM options (wings) or call options with strike prices above the current BTC price and puts with strike prices below BTC’s current market price. In other words, it means traders’ fear of tail risk or their sensitivity to uncertainty.
Calls are derivative contracts that give the buyer the right to buy the underlying asset at a later date at a predetermined price. A put option gives the right to sell. A call buyer is implicitly bullish on the market, while the put buyer is bearish. Demand for OTM calls and puts increases when traders anticipate an above-average price movement.
“If we look at the BTC Butterfly Index, we can see that the wings are near the upper 90 percentile (red horizontal line). [while] absolute volatility [metrics] “We seem confident that spot prices are consolidating, traders are still paying for tails,” said Greg Magadini, director of derivatives at Amberdata, in the weekly newsletter.
The index is expressed as a ratio, or spread, between crypto exchange Deribit’s Bitcoin Volatility Index (DVOL) and at-the-money volatility (ATM). Deribit’s DVOL considers pricing for all options, while the ATM tool is based on pricing for at-the-money options.
Tail risk pricing is consistent with ongoing macroeconomic uncertainty.
On Friday, Federal Reserve Chairman Jerome Powell reiterated that the central bank remains committed to meeting and maintaining the 2% inflation target, while signaling that monetary policy will remain tight for longer than expected.
The Fed’s continued tightening bias has pushed bond yields to their highest levels since 2007. Rising yields tend to weigh on risky assets, including cryptocurrencies.
“A key takeaway from Jerome Powell is that ‘to get inflation back to 2% probably requires below-trend growth’, which means he’s not afraid of some problems for the economy and jobs.” , remarked Magadini.
Ardern said tail risk is likely to remain higher ahead of Friday’s US nonfarm payrolls report. According to the Wall Street Journal, data is likely to show that the US economy added 200,000 jobs last month after adding 209,000 jobs in June, leading the unemployment rate to remain steady at 3.6%.
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