Short

For Bitcoin, Investing and Hedging Go Side-by-Side

Updated

Bitcoin (BTCUSD) fell below the psychologically important $30,000 level in the beginning of June, after it briefly reached $31,800 on May 30th. In early May, the leading cryptocurrency touched bottom around $25,000 amid the US stock market selloff.

Extreme price volatility is the trademark of Bitcoin throughout its history. Crypto investors’ optimism is short-lived, as the worst is not yet behind us. At $29,850, current Bitcoin price is -57% off the all-time high of $69,215 on November 8th, 2021.

A 1-year chart clearly shows an unstoppable downtrend. The Russia-Ukraine conflict is ongoing. China’s Zero-Covid policy and lockdowns slow down its economy and cloak up global supply chain. US inflation and gasoline price are at record-high, even after two rounds of Fed rate actions. On top of these, we never know when Elon Musk might send a tweet and spook the crypto market.

Long-term investors may “Buy and Forget” about the daily volatility and hope to see 100K Bitcoin in a few years. For Crypto asset, you don’t want to forget about it completely, as you might not remember how to retrieve it later. I have the unfortunate experience of losing a few ETHs when my iPhone 7 suddenly died. The unique word-combination required to unlock my wallet sits quietly in a safe in Wuhan, where I have not been able to return to since COVID first broke out there in January 2020.

For investors holding Bitcoin asset, hedging the downside risk is critical to successful investment. Usually, investors could lock in the price by shorting Bitcoin Futures. However, most of us do not want to give away the upside potential, so this strategy is not ideal.

I suggest buying CME Bitcoin Put Options instead. A Long Put gives you the right to sell at strike price during the life of the Options (American) or at contract expiration (European). When Bitcoin Futures trades below the Strike, you could exercise the options and pocket the price difference. Profit from options trade helps offset the loss incurred by holding the Bitcoin asset.

Let’s use the case below to illustrate: (1) On May 30, you buy an out-of-the-money Put with a Strike of 29000 on June 2022 CME Micro Bitcoin Futures. The option premium is $60 per contract. (2) At contract expiration, Bitcoin falls to 28000. You exercise the Put and receive a Short Futures position on CME Micro Bitcoin. (3) You immediately buy back a futures contract to close out your Short position. This trade earns you $1,000, which is the difference between market price and strike price. Minus the $60 premium, your options trading profit is $940. If you use the $60 as a cost base, your investment return will be 1567%.

What if Bitcoin rises above the Strike? Your investment in Bitcoin asset will increase in value. The premium you paid upfront is the maximum loss from the options trade. I consider this a low-cost insurance contract for protecting my Bitcoin asset.

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.

Note

In my debut on TradeView, I called out an "Unstoppable Downtrend" in Bitcoin and recommended buying CME Bitcoin Put Options. On June 2, Bitcoin was 30K. Today, it is 22K, down 25%.

Note

The "Unstoppable Downtrend" in Bitcoin! From 30K to 22K, and now below 16K.

JimHuangChicago

Jim W. Huang, CFA
jimwenhuang@gmail.com

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