A flattening futures curve

18 Oct 2022

A flattening futures curve

Leverage remains exceptionally high in BTC perps as open interest has stabilized above 500,000 BTC. This highly unusual ever-growing leverage trend remains a potent volatility catalyst for the crypto market.

Futures market still idle

The offshore futures basis remains flat compared to last week. The premiums were briefly impacted by the intraday volatility during the CPI release, reaching lows not seen since the FOMC but quickly recovered alongside BTC to 1%.

Preview

Source: Skew, Laevitas, Tradingview, CME *Closed Saturday - Sunday

Meanwhile, we note that CME’s futures align with the spot market. Nevertheless, since late August, CME’s futures have tended to trade below spot as institutional traders remain careful in the market.Related to CME’s futures, we note that Nassim Taleb has closed his profitable BTC short without providing any explanation. BTC’s extended losses, followed by a lengthy low volatility directionless environment, may have discouraged Taleb from maintaining his position due to the risks of a burst in volatility.

A flattening futures curve

Since the launch of the first U.S. futures-based ETFs, CME’s futures curve has softened, leading to less extensive underperformance of BITO versus BTC.

Preview

Source: Tradingview

One year ago, the next-month futures contract on CME traded at a 1% premium to the front-month (nearest month) expiry. However, the futures curve has flattened during the bear market, leading further-dated futures contracts to trade closer to the nearest dated contracts, leading rolling costs to decline. Throughout the year, the next-month contract has tended to trade at a slight premium to the front-month contract, but this premium has declined in recentmonths, and since September, CME’s futures structure has mostly trailed in backwardation. A state of backwardation benefits long ETFs such as BITO. Proshares sells the comparatively expensive contract (front month) to buy a cheaper contract (next expiry). Below, we illustrate the same chart since January 1st, 2019, demonstrating the unusually flat state of the CME futures curve of late.

CME in backwardation for the first time since May 2019

CME’s futures structure has trailed in backwardation throughout September. This has not happened since May 2019. Evidently, from the chart, the next-month expiry contract tended to trade at a 0.5-2% premium to the front-month contract from the summer of 2019 until April 2021.

Preview

Source: Tradingview

Simplified, a steeper futures curve (i.e., a high next-month premium over front-month expiry) indicates a bullish sentiment. Short sellers require a higher carry premium for longer-dated expiries, and longs are willing to pay a higher premium. Likewise, a flat futures curve or a downward trending curve implies the opposite – longs require compensation for the risk of exposure in further dated and less liquid BTC contracts.

Perps sticking to the status quo

Funding rates have mostly trailed below neutral in the last week.

Preview

Source: Skew, Bybit, Binance

The intraday volatility introduced by the CPI release led funding rates to fall into negative territory as longs were liquidated amid BTC’s push towards the lower $18,000. The BTCUSDT perp funding rates recovered to neutral levels on Monday as BTC stabilized above $19k, while Bybit’s funding rates remained below neutral. The CPI volatility was followed by a decline in open interest, which reached an intraday peak of 539k BTC prior to the release before declining to 500k BTC in the following hours. Nevertheless, open interest has stabilized above 500,000 BTC. The relative leverage in BTC derivatives remains alarmingly high, and the market is exposed to volatility-enhancing squeezes.

Open interest in BTC perps stabilizing above 500,000 BTC

Leverage remains exceptionally high in BTC perps. While CPI caused open interest to decline from an all-time high of 539,000 BTC, open interest has since stabilized slightly above 500,000 BTC. This highly unusual ever-growing leverage trend remains a potent volatility catalyst for the crypto market.

Preview

Source: Laevitas