BTC: Buying in the Dip?CME: BTC Futures ( CME:BTC1! )
Bitcoin plunged last week as investors focused on the payout of nearly $9 billion to investors of collapsed bitcoin exchange Mt. Gox. Spot price slumped to as low as $53,513 on Friday, marking the first time that bitcoin traded below the $55K level since Feb. 27th.
Another big bitcoin seller is the German government. In January, German police seized 50,000 bitcoins in connection with the prosecution of movie piracy operation Moview2k. Last week, they began selling thousands of bitcoins, adding to the current selloff pressure.
Last Friday, CME Bitcoin Futures ( CRYPTOCAP:BTC ) settled at 56,685, a drawdown of more than $15,300 or -21% since June. CME Ether Futures ( CRYPTOCAP:ETH ) closed at 2,997, down $900 or -23% in a month. Both cryptocurrencies are still up about 25% year-to-date.
Opinion: Bitcoin May Rebound and Reach New High
The big selling from Mt. Gox and the German government temporarily increased available bitcoin supply in the spot market, pushing its prices down. Both sellers could dump tens of thousands more bitcoins to the open markets in the coming weeks.
However, total bitcoin supply is still capped at 2.1 million. The recent halving event in April reduced newly mined bitcoin coming to market while increasing the cost of mining.
Meanwhile, the demand for crypto investment could increase substantially with bitcoin ETF funds. Once the dust is settled, we will have a market with limited supply and increasing demand. This is an economic formula for higher prices.
Unlike previous market downturns, the recent drawdown in bitcoin prices is not necessarily reflective of a bearish view from investors. The trustee managing Mr. Gox asset needs to sell bitcoins to make investors whole, ten years after its bankruptcy. The German government sells bitcoins also mainly for legal reasons.
Investors are not panicking. On the contrary, we hear that the founder of blockchain platform TRON offered to pay $2.3 billion to the German government for its entire bitcoin holding. This proposed private transaction is aimed at minimizing market volatility.
Additionally, escalated geopolitical tensions in Europe and Middle East also draw investors to cryptocurrencies, to diversify and hedge their assets.
We can find validation from CFTC Commitment of Traders report. As of June 25th, total open interest (OI) for CME Bitcoin Futures is 32,277 contracts. Asset managers has 17,531 contracts in long position, vs. only 493 contracts in short position. The 35-to-1 long-short ratio indicates strong bullish view from long-term bitcoin investors.
Overall, I hold the view that bitcoin would come out of the current downturn relatively quickly and would rebound and potentially reach new highs before the end of the year.
Long Futures with Put Protection
On May 6th, I published the idea, “HODL with a Twist”, and explored using Futures Rollover strategy to invest in bitcoin for the long haul.
Last Friday, the September Bitcoin Futures contract (BTCU4) was settled at 57,695. Each contract has a notional value of 5 bitcoins, or a market value of $288,475. To buy or sell 1 contract, a trader is required to post an initial margin of $69,234. The margining requirement reflects a built-in leverage of 4-to-1. It’s cost-effective investing with CME bitcoin futures, vs. buying bitcoins from bitcoin spot market or the ETF funds.
From bitcoin price history, we learn that it tended to reach new highs after market downturns. However, each drawdown could be very significant, and at times well over 50%. Today, as I reconfirm my bullish view, I also want to add protective put options to hedge our long futures position due to the risk of short-term market correction.
Last Friday, put strike at 50,000 for the September BTC contract was settled at 2,485. A trader will pay $12,425 (= 2,485 x 5) upfront to buy a put option.
Let’s use a hypothetical trade to illustrate how the long futures with protective put strategy differs from buying spot bitcoin or bitcoin ETF.
Hypothetical Trade:
• Buy 1 BTCU4 contract at 57,695, and set a stop loss at 50,000
• Buy 1 put option on BTCU4 at the 50,000-strike for $12,425
• Trader pays $69,234 initial margin for futures and $12,425 for put options, totaling $81,659
Scenario 1: Bitcoin drops to $36,000
• This is 50% drawdown from the high price reached in June
• Futures stop loss at 50,000, and the loss incurred in futures account will be $38,475 (= (57695-50000) x 5)
• Put options become exercisable at 50,000, and the gain will be $70,000 (= (50000-36000) x 5)
• The combined profit/loss for this strategy will be $31,525 (= 70000 – 38475)
• Investment return will be +38.6% (= 31525 / 81659)
• Comparison: With no leverage, investing in spot bitcoin or bitcoin ETF will lose 50%
Scenario 2: Bitcoin rises to $80,000
• This price will be a new record, which is 7.4% above all time high reached in March
• Futures gain will be $111,525 (= (80000-57695) x 5)
• Put options will expire worthless
• The combined profit/loss for this strategy will be $99,100 (= 111525 – 12425)
• Investment return will be +121.3% (= 99100 / 81659)
• Comparison: each bitcoin gains $22,305 (= 80000-57695). Investment return in spot bitcoin or bitcoin ETF will be +38% (= 22305 / 57695)
The above scenarios show that
• when bitcoin goes up, futures will have higher returns due to its leveraged nature.
• when bitcoin falls, protect put will kick in to reduce losses and may make a profit.
There are also risks in this strategy:
• If bitcoin goes up only modestly, futures return will lag spot bitcoin investment because of the added cost of the options premium;
• If bitcoin falls but stays above 50000, futures loss will be bigger than spot bitcoin investment, since the put options could not be exercised.
Happy Trading.
Disclaimers
*Trade ideas cited above are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management under the market scenarios being discussed. They shall not be construed as investment recommendations or advice. Nor are they used to promote any specific products, or services.
CME Real-time Market Data help identify trading set-ups and express my market views. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
