09 May 2022

Derivatives update: Leverage remains elevated in perpetuals

Perpetual swaps have seen massive growth in the open interest, leading the BTC denominated OI to explode beyond 2021 highs above 270,000 BTC.
Source: Skew, Laevitas
The BTC denominated open interest sits at elevated levels of 269,000 BTC after surging 11% on May 4th as we approached the FOMC meeting.The open interest quickly fell following the FOMC but has since risen again as leveraged exposure in the market grows.This leaves the market vulnerable to squeezes, both towards the upside but also towards the downside. While the open interest is always net neutral, funding rates can be used to assess the most aggressive contributor in the build-up. Most of the build-up in OI has been accompanied by funding rates below neutral.However, with bitcoin trading near macro lows, traders might have betted on a new reversal at strong support. We see that the funding rates have been neutral since BTC declined below $35,000 (next slide). This is possibly a dangerous setup that could create a painful deleveraging event if the stock market sees further downside while correlations remain intact.Yesterday’s chaos in the market caused the largest liquidation cascade in bitcoin since January 21st, but it was minor in comparison to what we saw in 2021. It is relatively uplifting that yesterday’s chaos did not result in a larger liquidation cascade, as this suggests that traders are conservative with their leverage.Nevertheless, with March 12th, 2020, in mind, it’s worthwhile being prudent. Breakouts below $28,000 could become explosive. While a short squeeze is definitely possible, chasing bottoms in bear markets is a dangerous endeavor.
Funding rates neutral since plunge below $35,000
Funding rates did reach negative territory as BTC sold off below $38,000 and down towards $35,000. This was likely driven by fear and liquidations.However, funding rates have remained neutral since bitcoin fell below $35,000.This shows that perps have followed the spot market closely amid the shaky markets in recent days. Usually, funding rates tend to plummet following such sell-offs.
Source: Skew
This could suggest that traders are more willing to add long exposure with bitcoin trading near the absolute bottom of its near 1.5 year-long trading range.Nevertheless, funding rates have still remained neutral to below neutral since December 4th, indicative of prevailing negative sentiment.
Futures premiums stays below 4%
Futures basis still sit below 4% in the offshore market, mostly trailing around 3% in the offshore market.The FTX basis grew from 3% to 4% during yesterday’s mayhem in the market. Several factors might have contributed to this growth. It could be caused by growing demand for long exposure as bitcoin trades near its 1.5-year-long support, but it could also be caused by hedging activity related to the UST situation.Meanwhile, CME’s premium stays low, trailing around yearly lows. CME’s basis saw a decline towards the FOMC meeting last Wednesday, suggesting that institutional traders were concerned ahead of the interest rate hike decision.
Source: Skew
The basis on CME has since climbed slightly, but it remains very low at 1.11%, in line with the low levels from February 28th.In sum, the futures basis shows that active traders in the market remain pessimistic, largely seeking to hedge.
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