Client:

Trader with physical Bitcoin position

Challenge:

Protecting their position from potential price decreases

Solution:

Hedging with options on Micro Bitcoin futures

Overview

A trader is long $10,000 worth of physical Bitcoin.  They are concerned about downside moves in the Equities market having a negative impact on the position.  The trader wants to reduce their exposure to a potential price decline but believes in the long-term potential of cryptocurrency.  They decide to use options on Micro Bitcoin futures to partially hedge their exposure – specifically purchasing a Micro Bitcoin put option.  A put option is the right to sell the underlying futures contract at a certain price. 

Scenario

Assume the price of bitcoin is currently $36,190.  As Micro Bitcoin futures are 1/10th the size of one bitcoin, the notional value of one Micro Bitcoin futures price would be $3,619.  This represents approximately 36% of the trader’s bitcoin exposure.  The trader is looking at purchasing the 36,000 put.  If the put option finishes in-the-money, that would give the trader the right to sell the Micro Bitcoin futures at $36,000. 

As the number of options needed to hedge one futures contract is determined by the option delta, assume the theoretical delta of the option is -.46 or a -46 delta.  The trader purchases two 36,000 puts to hedge their exposure to a potential downside price move in bitcoin. The total delta of the position is -92.  This is the delta upon the initiation of the trade but will change as time, volatility and price of the underlying changes. In theory, this represents 92% of one futures contract ($3,619) or the equivalent of approximately $3,330.  This partial hedge protects about 36% of the trader’s physical position if the price of bitcoin drops dramatically.

The theoretical premium of one put is 1,965.60.  The trader purchases two put options for a total of 3,931.20 (2 x 1,965.60). With the .10 contract multiplier, this equates to $393.12.  Assume, volatility is currently at 60% and there are 21 days until the option expiration.   

Volatility: 60%

Theoretical Delta: -92 (-.46 x 2)

DTE

Bitcoin futures Price ($)

Option Premium (pts)

Option Premium ($)

P&L Underlying

position

P&L options

Total P&L

21

36,190.00

3,931.20

393.12

 

 

 

Figure 1: Micro Bitcoin option position: Long 2-36,000 puts

Two weeks elapse and the position has undergone price fluctuations and theta decay, but volatility remains the same. Let’s review three different market scenarios and the effect on the trader’s profit and loss (P&L).   

P&L Scenarios

Scenario 1
The price of bitcoin declines by $5,000 after the news breaks.  The options premium increases while the underlying position decreases.  The total P&L is -$806.86.  Due to the hedge, the loss was decreased by $574.74. 

DTE

Bitcoin futures Price ($)

Option Premium (pts)

Option Premium ($)

P&L Underlying position

P&L options

($)

Total P&L ($)

6

31,190.00

 9,678.54

967.86

(1,381.60)

 574.74

(806.86)

Figure 2: Theoretical P&L with 5,000 Micro Bitcoin futures decrease

Scenario 2
The price of bitcoin declines by $10,065 after the news breaks. Again, the increase in the option premium mitigates the greater loss of the underlying position.

DTE

Bitcoin futures Price ($)

Option Premium (pts)

Option Premium ($)

P&L Underlying

Position

P&L options ($)

Total P&L ($)

6

26,125.00

19,744.40

1,974.44

(2,781.20)

1,581.32

(1,199.88)

Figure 3: Theoretical P&L with 10,000 Micro Bitcoin futures decrease

Scenario 3
The price of bitcoin rallies by $5,000 after the new breaks.  Some of the potential gains of the underlying are decreased by the loss on the option position. 

DTE

Bitcoin futures Price ($)

Option Premium (pts)

Option Premium ($)

P&L Underlying

Position ($)

P&L options ($)

Total P&L ($)

6

41,035.00

105.92

10.59

 1,339.00

(382.53)

956.47

Figure 4: Theoretical P&L with 5,000 Micro Bitcoin futures increase

Results

By hedging with options on Micro Bitcoin futures, the trader was able to protect a portion of their physical position from a potential price decline while still benefitting from an increase in the underlying. 

Conclusion

Options on Micro Bitcoin and Micro Ether futures may be used as a risk management tool for physical cryptocurrency exposure.


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