Last night, Cboe XBTSM Bitcoin Futures commenced trading on the Cboe Futures Exchange.  The launch was smooth, although our website experienced some issues due to an overwhelming number of hits looking for the trading data.  Now that the futures are up and running, it may be time for a brief explanation of how an owner of bitcoins may use futures to hedge their position. 

The initial futures contracts that traded in Chicago were on crops such as corn or wheat.  Farmers could use futures to lock in a selling price before they even planted their crops for the grown season.  Bitcoin futures allow market participants the ability to lock in a selling price for bitcoin as of a future date. 

Bitcoin Curve

Currently the front month future is the January contract which at last check could be sold for $17,600.  This contract settles in a cash transfer based on the 4:00 pm eastern bitcoin auction price on Wednesday January 17, 2018 established by Gemini who is partnering with Cboe Global Markets.  The bitcoin price at Gemini is close to $16,600 so I will use that for the underlying bitcoin price in this example. 

Let’s say Larry owns one bitcoin and the current price is $16,600, be believes the price is overdone to the upside for a short period of time.  This is a fictional example, so don’t beat me up on the outlook, you can criticize Larry, but he’s made up too.  Larry has a futures account and sees that he can sell short a January XBT Future at $17,600.  He decides to do this and is now short 1 January XBT Future at $17,600. 

He now is long a bitcoin and short a January XBT futures contract.  Let’s fast forward to settlement on January 17th.  Larry has held is futures through the settlement and here are the potential outcomes based on various settlement prices. 

bitcoin PL

Note that any losses on the bitcoin position is offset by the short position in the Jan XBT Futures contract.  Because Jan XBT was trading at a $1,000 premium to spot bitcoin, the profit for this trade is equal to that difference.  Now, keep in mind if bitcoin doubles between now and January 17 settlement the maximum profit is $1000.  Larry is giving up some upside to assure a return of $1000.

Finally, Larry can always cover his short in the XBT Futures contract.  If bitcoin drops dramatically on the short term and the futures contract drops in line with the spot price, he could always buy back the future, take a profit and have that profit offset the unrealized loss he experienced in his spot bitcoin.

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