Futures Expiration Causes Extreme Bitcoin Volatility

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Futures Expiration Causes Extreme Bitcoin Volatility

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The Bitcoin market experienced extreme volatility on 19 September 2018, dropping from USD 6,330 to USD 6,100 (-3.6%) in an hour, and then rapidly rising to USD 6,550 (+7.4%) only half an hour later, before dropping again to USD 6,400 (-2.3%) in the next half hour before stabilizing. This rapid and isolated Bitcoin price volatility event coincided with the monthly expiration of Bitcoin futures contracts on the Chicago Board Options Exchange (CBOE), and it is likely that this was the cause of this volatility.

Thomas Lee, the Head of Research at Fundstrat Global Advisors, proposed that the expiration of monthly futures contracts on Bitcoin futures exchanges in Chicago leads to market volatility, particularly price drops. Lee found that on average, from six months of data, Bitcoin’s price drops 18% in the ten days leading up to futures contract expiration.

The mechanism behind this is traders use Bitcoin futures to create short positions, where they make money if Bitcoin’s price drops. Simultaneously they hold actual Bitcoins, and then sell these Bitcoins before futures contract expiration to drive Bitcoin’s price down, increasing their short profits. This volatility event on 19 September is good proof of this theory, since price crashed right before the futures contracts expired, suggesting someone in a short position was trying to drive spot price down at the last minute to make quick profits.

There are two potential reasons for the rally that quickly followed the crash. Perhaps once the Bitcoin futures contracts expired, the investors who sold their Bitcoins bought them back, driving price up. Additionally, the Relative Strength Index (RSI) briefly dropped below 30 during the crash, indicating oversold conditions, which is a relatively rare occurrence for Bitcoin. Other traders and investors who use the RSI to make decisions probably saw this and quickly bought Bitcoin during the time RSI was below 30.

The combination of futures traders buying back Bitcoin, and other traders buying Bitcoin due to the oversold RSI, actually drove RSI up to 68 for a moment, just below the overbought threshold. Some of the same traders who make decisions with RSI might have sold at this point, leading to the slight price drop back to USD 6,400.


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