Ethereum rallied 33% in the last five days and the data represents that as this occurred some buyers began to use excessive leverage. It is not something negative, but it should be considered a yellow flag as there will be a higher premium on futures contracts for short periods is normal.
For a long time, Ether’s price was continuously moving upwards, it is only in February that Ethereum broke its record of $1,500 and entered the price discovery mode. To evaluate whether the market is overly optimistic, it is necessary to review a few metrics. One is the futures premium and it measures the price difference between the contract prices and the regular spot market.
The 3-month futures must trade with a 6% to 20% annual premium and it should be cleared as a lending rate. Postponing the settlement, sellers demand higher prices and it creates a price difference.
According to the above chart, Ether futures premium is above 5.5% that is unsustainable. As there are less than 49 days for Mar. 26 expiry, the rate is equivalent to a 55% annualized basis.
A sustainable basis of a value above 20% indicates excessive leverage from buyers and creates a good potential for massive liquidations and market crashes. A similar event took place on Jan. 19 as Ethereum broke its record of $1,400, but it could not sustain at that level. This situation triggered the liquidations that followed and Ethereum price increased by 27% in the next two days.
The basis level above 20% does not indicate a pre-crash alert but it indicates higher leverage from futures contract buyers. The over-confidence of the buyers will only impose a greater risk if the market decreases below $1,450. It was the price level when the indicator broke 30% and reached alarming levels. It is also necessary to note that the traders will increase their use of leverage in the middle of the rally and also purchase the digital asset to balance the risk.
Sellers were not liquidated with the price hike of $1,750
Whoever is betting on $2,000 Ether should be happy to know that open interest has been increasing in the recent 33% rally. This situation depicts that the short-sellers are fully hedged, enjoying the benefits of the futures premium, instead of thinking about any downside.
This week, Ether futures’ open interest reached a record of $6.5 billion which is a 128% monthly increase. Professional investors who are following the above strategy and performing cash and carry trades that consists of buying the underlying asset and selling the futures contracts.
These arbitrage positions of Ethereum does not represent any liquidation risks. Hence, the current surge in open interest is a positive indicator.