Bitcoin recently reached new highs for 2023. But, there is still a question: Has the market become over-extended? And have we reached a pinnacle in terms of excitement? The crypto options market can provide some insight into these questions.

The rally in Q4 of 2020 is the best comparison for Q4 2023. By superimposing BTC return for both years, it is possible to discern a strikingly comparable narrative.

(BTC Spot Performance 2020 Green and 2023 Orange)

The implied volatility (which represents the investor’s bet about BTC’s future realized volatilities) is currently hovering around its 2023 high, driven primarily by the purchase of call options. This could mean that the market has already factored in the explosive potential upside we all hope for.

When we examine the implied volatility for BTC in the last four years, the level is still relatively low, suggesting that BTC’s explosive rally has not yet been demonstrated. The accompanying option volatility was around 150% when BTC surged during Q4 2020. Today, it is at about 50%.

(BTC implied volatilty for “at the money” options)

You can also compare the historical basis of futures today with that of January 1, 20. The futures basis for Deribit back then was 20 percent annualized. This is 17 times the risk-free 10-year rate. The futures basis today is about 10%, or 2.4x the risk-free rate. The large disparities between the current spot price and that of 2020 do not necessarily indicate higher prices. However, they do suggest a significant amount of potential purchasing power.

It’s important to note that implied volatility options traders are willing pay is closely linked to the actual volatility BTC experiences (realized volatility), and that volatility has reached new lows in the year 2023. The Variance Risk Premium, or VRP, is the term used to describe this connection. It has grown since mid-October. Recent option traders have been willing to pay an increased premium for BTC volatility, anticipating explosive moves.

(BTC implied volatility term structure)

Currently, we’re seeing a particularly pronounced “kink” in implied volatility for the January expiration month. This is due to the expectation that the Securities and Exchange Commission (SEC) will approve/deny Bitcoin spot ETFs. Markets are therefore moving.

Forward volatility (the implied volatility difference between the December 29 expiration date and the contract for January) is currently around 57%. This represents a premium of 12 points over the 30-day realized volatility, which is 45%.

This suggests either that the option buyers are placing incorrect bets or overpaying for them, or that BTC’s volatility will continue to grow.

Benjamin Schiller is the editor.