Bitcoin - Buckle Up for the Downward Spiral Ride
CME: Micro BTC Futures (
MBT1!) and BTC Options (BTC1!)
On December 11th, Bitcoin is trading at $16,890, down 63% year-to-date. Current price falls below 50-day moving average (MA) of $18,300 and 200-day MA of $26,470.
Meanwhile, Open Interest of CME Bitcoin Futures (BTC) has been growing from about 8,000 lots to 14,000 in December. This strongly suggests that Bitcoin investors are bearish and increasingly use futures to hedge their investments.
Is Bitcoin a commodity, a security or a currency?
This is a $1 trillion question. Regardless of your own view, what really matters is how financial regulator in your country of residence defines it.
In the US, there is a turf war among federal regulators for oversight of the crypto market. A recent Senate bill, if becomes law, would task Commodity Futures Trading Commission (CFTC) as the primary regulator for Bitcoin and Ether.
Indeed, Bitcoin shares key characteristics with other commodities. It’s homogeneous (all Bitcoins are of the same quality), fungible (can be divided up to trade), and with finite supply (21 million in all). Just like gold, it takes labor and cost to mine new Bitcoins and they can be stored for future use.
We can’t say the same for other cryptocurrencies. Those issued through an initial coin offering (ICO) resemble stock IPO, and could fall under the jurisdiction of SEC. As a stock investor, you understand that any company could go bankrupt, rendering its stocks worthless. So is the risk of any ICO.
Bitcoin is a virtual currency, even the CFTC says so on its website. It facilitates transactions across borders and can be stored as a means for wealth. However, price volatility of Bitcoins is too large to make it a functional currency, limiting its appeal to the general public.
Risks Associated with Bitcoin Investment
Let’s say we agree that Bitcoin is a commodity. We need to understand its unique risks compared with other types of financial assets.
Firstly, extremely high volatility. Below is annualized volatility of various markets. While Bitcoin promoters point to its decentralized structure as a safe investment, it is nevertheless a very risky asset as measured by the off-the-chart price volatility.
• Bitcoin: 80.6% (as of December 4th)
• S&P 500: 24.01% (as of December 9th)
• Gold: 16.45% (as of December 8th)
• Euro/USD: 24.71% (as of December 9th)
• WTI Crude Oil: 46.82% (as of December 7th)
• 10-Year Treasury Note: 6.41% (as of December 11th)
Secondly, extremely vulnerable to event risks. Bitcoin is built upon global consensus. An unexpected major event could result in a market rally if it strengthens such consensus. On the other hand, Bitcoin price could be crashed, if the consensus is weakened.
• El Salvador announces to make Bitcoin a legal tender (market rally)
• Elon Musk tweets that Tesla no longer accepts Bitcoin as payment (market crash)
• China bans cryptocurrency trading and mining (market crash)
Thirdly, regulatory risks. If you trade on an unregulated Exchange, your crypto assets do not enjoy the same legal protection as a trading account at New York Stock Exchange or Chicago Mercantile Exchange would have. The demise of No. 2 Crypto Exchange FTX serves as an example of such risks.
Finally, crypto assets are vulnerable to hacking whether you store them with an Exchange or in a digital wallet. You also run the risk of not being able to retrieve your bitcoins if you forget the private keys or misplace your password.
Bitcoin Trading Using Futures Contracts
Every trade has a Long and a Short. If you have a short-term trading horizon, you should be prepared to take either side depending on whether you are bullish or bearish.
BTC futures are good instruments to express your view with limited amount of money. CME Micro BTC (MBT) is based on 1/10 of 1 BTC. Initial margin is $430 per contract, about ¼ of the full cash value.
For anyone who is a HODLer and invests in Bitcoin for the long haul, its 63% decline in a year is very hard to swallow. Hedging your position is a good way to minimize large drawdown on your portfolio. Put options on BTC futures is a vehicle to achieve just that.
In my trade idea published in June, I called out an "Unstoppable Downtrend" in Bitcoin and recommended buying CME BTC Put Options. On June 2nd, Bitcoin was 30K. On June 14th, it dropped 25% to 22K. If you bought a put option of BTCM2, you could have realized a sizable return. (Please read the original trade idea for details.)
Where will BTC go from here?
Technical indicators suggest potential breakout to the downside, as we discussed earlier.
Fundamentally, I think that Fed rate hike is the dominant price driver across global financial markets these days, stocks, bonds, FX, commodities and crypto included.
BTC price is inversely related to treasury yield. If the Fed sticks to a 75-bp hike, 10-Year Yield would rise and BTC could fall. However, if the Fed moderates to a 50-bp increase, the opposite could happen. Therefore, I would watch the FOMC decision on December 14th closely. This would guide us for longer-term market direction in 2023.
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 trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs tradingview.com/gopro/
MBT1!) and BTC Options (BTC1!)On December 11th, Bitcoin is trading at $16,890, down 63% year-to-date. Current price falls below 50-day moving average (MA) of $18,300 and 200-day MA of $26,470.
Meanwhile, Open Interest of CME Bitcoin Futures (BTC) has been growing from about 8,000 lots to 14,000 in December. This strongly suggests that Bitcoin investors are bearish and increasingly use futures to hedge their investments.
Is Bitcoin a commodity, a security or a currency?
This is a $1 trillion question. Regardless of your own view, what really matters is how financial regulator in your country of residence defines it.
In the US, there is a turf war among federal regulators for oversight of the crypto market. A recent Senate bill, if becomes law, would task Commodity Futures Trading Commission (CFTC) as the primary regulator for Bitcoin and Ether.
Indeed, Bitcoin shares key characteristics with other commodities. It’s homogeneous (all Bitcoins are of the same quality), fungible (can be divided up to trade), and with finite supply (21 million in all). Just like gold, it takes labor and cost to mine new Bitcoins and they can be stored for future use.
We can’t say the same for other cryptocurrencies. Those issued through an initial coin offering (ICO) resemble stock IPO, and could fall under the jurisdiction of SEC. As a stock investor, you understand that any company could go bankrupt, rendering its stocks worthless. So is the risk of any ICO.
Bitcoin is a virtual currency, even the CFTC says so on its website. It facilitates transactions across borders and can be stored as a means for wealth. However, price volatility of Bitcoins is too large to make it a functional currency, limiting its appeal to the general public.
Risks Associated with Bitcoin Investment
Let’s say we agree that Bitcoin is a commodity. We need to understand its unique risks compared with other types of financial assets.
Firstly, extremely high volatility. Below is annualized volatility of various markets. While Bitcoin promoters point to its decentralized structure as a safe investment, it is nevertheless a very risky asset as measured by the off-the-chart price volatility.
• Bitcoin: 80.6% (as of December 4th)
• S&P 500: 24.01% (as of December 9th)
• Gold: 16.45% (as of December 8th)
• Euro/USD: 24.71% (as of December 9th)
• WTI Crude Oil: 46.82% (as of December 7th)
• 10-Year Treasury Note: 6.41% (as of December 11th)
Secondly, extremely vulnerable to event risks. Bitcoin is built upon global consensus. An unexpected major event could result in a market rally if it strengthens such consensus. On the other hand, Bitcoin price could be crashed, if the consensus is weakened.
• El Salvador announces to make Bitcoin a legal tender (market rally)
• Elon Musk tweets that Tesla no longer accepts Bitcoin as payment (market crash)
• China bans cryptocurrency trading and mining (market crash)
Thirdly, regulatory risks. If you trade on an unregulated Exchange, your crypto assets do not enjoy the same legal protection as a trading account at New York Stock Exchange or Chicago Mercantile Exchange would have. The demise of No. 2 Crypto Exchange FTX serves as an example of such risks.
Finally, crypto assets are vulnerable to hacking whether you store them with an Exchange or in a digital wallet. You also run the risk of not being able to retrieve your bitcoins if you forget the private keys or misplace your password.
Bitcoin Trading Using Futures Contracts
Every trade has a Long and a Short. If you have a short-term trading horizon, you should be prepared to take either side depending on whether you are bullish or bearish.
BTC futures are good instruments to express your view with limited amount of money. CME Micro BTC (MBT) is based on 1/10 of 1 BTC. Initial margin is $430 per contract, about ¼ of the full cash value.
For anyone who is a HODLer and invests in Bitcoin for the long haul, its 63% decline in a year is very hard to swallow. Hedging your position is a good way to minimize large drawdown on your portfolio. Put options on BTC futures is a vehicle to achieve just that.
In my trade idea published in June, I called out an "Unstoppable Downtrend" in Bitcoin and recommended buying CME BTC Put Options. On June 2nd, Bitcoin was 30K. On June 14th, it dropped 25% to 22K. If you bought a put option of BTCM2, you could have realized a sizable return. (Please read the original trade idea for details.)
Where will BTC go from here?
Technical indicators suggest potential breakout to the downside, as we discussed earlier.
Fundamentally, I think that Fed rate hike is the dominant price driver across global financial markets these days, stocks, bonds, FX, commodities and crypto included.
BTC price is inversely related to treasury yield. If the Fed sticks to a 75-bp hike, 10-Year Yield would rise and BTC could fall. However, if the Fed moderates to a 50-bp increase, the opposite could happen. Therefore, I would watch the FOMC decision on December 14th closely. This would guide us for longer-term market direction in 2023.
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 trade set-ups and express my market views. If you have futures in your trading portfolio, check out on CME Group data plans in TradingView that suit your trading needs tradingview.com/gopro/
Jim W. Huang, CFA
jimwenhuang@gmail.com
jimwenhuang@gmail.com
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