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.
This material is directed only at, persons who are: (i) investment professionals (as that term is defined in article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (“FPO”)), (ii) high net worth companies (as that term is defined in article 49 of the FPO) or (iii) any other persons to whom it may lawfully be communicated. Accordingly, persons who (i) do not have professional experience in matters relating to investments or (ii) are not high net worth companies, should not act or rely on this material. The financial instruments and / or services detailed in this material will only be available to high net worth companies or investment professionals (as defined above). If you are not a high net worth company or investment professional (as defined above) you cannot invest directly and are unable to gain access to the relevant financial instruments. CME GROUP DOES NOT REPRESENT THAT ANY MATERIAL OR INFORMATION CONTAINED HEREIN IS APPROPRIATE FOR USE OR PERMITTED IN ANY JURISDICTION OR COUNTRY WHERE SUCH USE OR DISTRIBUTION WOULD BE CONTRARY TO ANY APPLICABLE LAW OR REGULATION.
