When Bitcoin (BTC) lost $ 52,000 in support on April 22nd, the funding rate for futures contracts entered negative territory. This unusual situation causes the discounted shorts to pay fees every eight hours.
While the interest rate itself is slightly damaging, this situation creates incentives for arbitrage desks and market makers to buy inverse swaps while selling the future monthly contracts. The cheaper it is for long-term leverage, the greater the incentive for bulls to open positions, creating a perfect “bear trap”.
The graph above shows how unusual a negative funding rate is and usually doesn’t last long. As the latest April 18 data shows, this indicator should not be used to predict market lows, at least not in isolation.
Monthly futures contracts are better suited to longer-term strategies
Futures contracts typically trade at a premium – at least in neutral to bullish markets through 2014, and this applies to any asset including commodities, stocks, indices and currencies.
However, cryptocurrencies have recently seen an annualized (base) premium of 60% which is viewed as very optimistic.
In contrast to the open-ended contract (inverse swap), the monthly futures have no financing rate. As a result, their price will be very different from the regular spot exchanges. These fixed calendar contracts eliminate the fluctuations in financing rates and are the best tool for longer-term strategies.
As shown in the graph above, notice how the 1 Month Futures Premium (Base) has stepped into dangerously above average levels, exhausting the possibilities for bullish strategies.
Even those who had previously bought futures in anticipation of another rally above the all-time high of $ 64,900 had incentives to reduce their positions.
The lower cost of bullish strategies could be bear traps
While 30% or more of the cost of opening long positions is prohibitive for most bullish strategies as the base rate drops below 18%, for long futures it usually becomes cheaper than buying call options. This $ 11 billion derivatives market has traditionally been very costly to bulls, largely due to the characteristically high volatility of BTC.
For example, buying upside protection with a $ 60,000 call option for June 25 currently costs $ 4,362. This means the price must rise to $ 64,362 for the buyer to benefit – a 19.7% increase from $ 50,423 in two months.
While the call option contract offers infinite leverage over a small upfront position, it makes less sense for bulls than the 3% June futures premium. A 5-fold leveraged long position brings 120% profit if BTC happens to hit the same $ 64,362. Meanwhile, the $ 60,000 call option buyer would require the price of Bitcoin to rise to $ 77,750 for the same profit.
While investors have no reason to celebrate the 27% correction that has occurred over the past nine days, investors might interpret the move as a “glass half full”.
The lower the cost of bullish strategies, the greater the incentive for bulls to set up a perfect “bear trap” that leads Bitcoin to a more comfortable $ 55,000 support.
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