Sharp Bitcoin price move brewing as BTC volatility falls to a 16-month low

Bitcoin (BTC) options aggregate open interest has increased to $2 billion, which is 13% below the all-time high. Although the open interest is still heavily concentrated on Deribit exchange, the Chicago Mercantile Exchange (CME) has also reached $300 million.

In simple terms, options derivatives contracts allow investors to buy protection, either from the upside (call options) or downside (put options). Even though there are some more complex strategies, the mere existence of liquid options markets is a positive indicator.

For example, derivative contracts allow miners to stabilize their income which is tied to a cryptocurrency’s price. Arbitrage and market-making firms also utilize the instruments to hedge their trades. Ultimately, deeply liquid markets attract larger participants and increase their efficiency.

Implied volatility is a useful and primary metric that can be extracted from options pricing. Whenever traders perceive increased risk of larger price oscillations, the indicator will shift higher. The opposite occurs during periods when the price is flat or if there is expectation of milder price swings.

3-month options contracts implied volatility. Source: Skew

Volatility is commonly known as a fear indicator, but this is mostly a backward-looking metric. The 2019 spike seen on the above chart coincided with the $13,880 peak on June 26, followed by a sudden $1,400 decline. The more recent volatility spike from March 2020 happened after a 50% decline occurred in just 8 hours.