While bitcoin's rally over the past month has revived talks of its price reaching new record highs above $20,000 by the end of the year, the cryptocurrency's options market continues to assign a very low probability of that scenario playing out.
"A below-10% probability of record highs by the year end means the market is unconcerned with that outcome," Vishal Shah, an options trader and founder of Polychain Capital-backed derivatives exchange Alpha5 told CoinDesk in a Telegram chat.
An option is a derivative that gives the purchaser the right but not the obligation to buy or sell the underlying asset at a specific price on or before a particular date. A call option gives its owner the right to buy something while a put option gives the right to sell.
Option probabilities are calculated using the Black-Scholes formula based on critical metrics such as call options' prices, strike prices, the price of the underlying asset and the "risk-free" interest rate on investments as U.S. Treasurys and the time to maturation.
Market underpricing record high probability?
Bitcoin's price has rallied from $3,867 to $13,800 over the past 7½ months. However, while prices have risen by over 250%, the chances of bitcoin reaching record highs by the end of the year have seen what appears to be a marginal rise from 4% to 6%. The probability peaked at 8% in July.
As such, one may conclude the options market is underpricing the possibility of prices rising to $20,000 before Dec. 31.
However, that's not necessarily the case because bitcoin now has just eight weeks to chart a 50% rally to $20,000. Back in March, bitcoin had three quarters – nine months – to challenge record highs. As the time to expiration decreases, the probability of prices rising beyond a particular level declines.
Besides, bitcoin has appreciated by 50% or more in two months only eight times in its 10-year history, and three out of the eight bi-monthly 50% price rallies have happened during the bull market frenzy of 2017.
Considering the decline in the time left for December expiry and bitcoin's historical price action, the options market may appear rational in pricing a 6% probability of the cryptocurrency reaching lifetime highs by the end of December.
“The options market is seemingly not getting carried away with the recent strong price momentum," Sui Chung, CEO of CF Benchmarks, said in a statement to CoinDesk. Chung added that, "if we extrapolate bitcoin's price action and volatility of the past 90 days till December expiry, then bitcoin appears set to end the year between $14,000 to $15,000."
The options market currently sees a 40% probability of prices trading above $14,000 by the end of the year.
Some traders may argue the options market is overpricing the odds of bitcoin rising above $20,000. That's because the three-month implied volatility (IV), or investors' expectations of how volatile prices could be over the next quarter, is hovering well above the three-month realized volatility (RV), or price deviations, seen over the past quarter.
Currently, three-month IV is seen at 3.2%, and the RV is hovering at 2.5%. Option market probabilities have a positive correlation with implied volatility.
Looking ahead, the odds of prices setting a new record high this year would rise if the cryptocurrency charts a quick move above the June 2019 high of $13,880. According to technical charts, there is very little resistance between $13,880 and $20,000.