Pro traders go short as overbought derivatives propel Ethereum’s new high

Ether’s (ETH) performance over the past week has been nothing short of exceptional. The price rallied from a $905 low on Jan. 11 to a new all-time high at $1,440 on Jan. 19. 

According to Cointelegraph, the main reasons fueling this move are the growth of decentralized finance (DeFi) protocols as the total value locked reached $24 billion, Ethereum daily transactions surpassing 1.2 million and Bitcoin (BTC) price consolidating below $40,000.

Nevertheless, the latest leg of Ether’s rally on Jan. 19 presented a different dynamic from the previous breakouts. A much use of derivatives leverage has been deployed this time and the top traders at the biggest exchanges have been opening short positions.

9 days after making a multi-year high at $1,350, Ether price corrected by 33% so top traders may have opened short positions with the expecation that the same thing would happen again. It is also worth noting that just a week ago centralized exchanges recently reached their lowest Ether reserve levels since August 2019.

Although there is some discussion whether part of this Ether exodus is an internal transfer between Bitfinex cold wallets, there has been a clear net withdrawal trend since August 2020. This data coincides with the DeFi’s emergence and shows that investors chose to take advantage of yield opportunities outside centralized exchanges.

The futures premium spiked

Professional traders tend to dominate longer-term futures contracts with set expiry dates. By measuring the expense gap between futures and the regular spot market, a trader can gauge the level of bullishness in the market.

The 3-month futures should usually trade with a 6% to 20% annualized premium (basis) versus regular spot exchanges. Whenever this indicator fades or turns negative, this is an alarming red flag. This situation is known as backwardation and indicates that the market is turning bearish.

On the other hand, a sustainable basis above 20% signals excessive leverage from buyers, creating the potential for massive liquidations and eventual market crashes.

The above chart shows that the indicator ranged from 3.5% to 5.5% over the past four weeks, translating to a moderately bullish 19% annualized basis. Meanwhile, the recent 6.5% peak is equal to a 29% annualized premium and is somewhat worrisome.

Overbought derivatives levels should be deemed a yellow flag, although maintaining them for short-term periods is normal. Traders might have momentarily exceeded their regular leverage during the rally but also purchased the underlying asset (Ether) to adjust the risk. If this did happen, the next 48 hours will determine whether or not the spiking futures premium is a red flag.

Spot volume peaked but remains strong

In addition to monitoring futures contracts, profitable traders also track volume in the spot market. Typically, low volumes indicate a lack of confidence. Therefore significant price changes should be accompanied by robust trading activity.

This week Ether has managed $4.7 billion in daily average volume and while this figure is far from the $12.3 billion all-time high seen on Jan. 11, it is still 160% higher than December. Even with the volume drop, the recent price peak's resounding trading activity is a positive indicator.

Top traders decided to short Ether at the all-time high

Exchange-provided data highlights traders' long-to-short net positioning. By analyzing every client's position on the spot, perpetual and futures contracts, one can obtain a clearer view of whether professional traders are leaning bullish or bearish.

With this said, there are occasional discrepancies in the methodologies between different exchanges, so viewers should monitor changes instead of absolute figures.

Across each of the three exchanges analyzed, there has been a consistent rise in net short activity over the last 24 hours. This move was even more evident at OKEx as its top traders index made a drastic move from favoring bulls at 1.64 to being tilted toward bears at 0.91. This indicates that the top traders have a net short exposure.

Before jumping to conclusions on whether Ether is now bullish or bearish, it’s good to remember that arbitrage desks and market makers encompass a vast portion of exchanges' top traders. The unusually large futures premium would incentivize those clients to create heavy short positions in futures contracts while simultaneously buying Ether spot positions.

Ether’s derivatives data is a tad bit concerning right now and the top traders don't seem to be bullish. These are signals that investors should proceed with caution instead of turning into perma-bulls just because Ether reached a new all-time high.

The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph. Every investment and trading move involves risk. You should conduct your own research when making a decision.