A Bitcoin For Your Thoughts

Hey Traders,

One of the hot topics of the week was the debut of the first Bitcoin ETF, ProShares Bitcoin Strategy ETF.

The ETF shares rallied nearly 5% on their first day of trading …

But even more exciting (to me) are BITO options, which began trading last Wednesday.

Of course, it’s only a matter of time until more bitcoin ETFs (and their options contracts!) flood the market — VanEck is already reportedly planning to launch their own Bitcoin Strategy ETF under the ticker XBTF, and there’s sure to be plenty more to come after that.

However, before you hop on board and snap up shares of these volatile equities, there’s something you NEED to know …

Including why I would advise AGAINST a buy-and-hold strategy!

A Little Bit On BITO

The most important thing to know about BITO is that it doesn’t track the actual value of bitcoin itself …

Rather, the ETF tracks bitcoin futures.

This is where a lot of rookie retail investors are going to get burned.

The best way I can explain it to you is by taking a look at the VIX futures curve.

Now, the VIX futures curve tracks where futures are trading relative to the actual VIX index.

Typically (like, 80% of the time) the curve is in contango. This means that VIX futures are trading subsequently higher than the VIX itself.

For example, take a look at the VIX futures curve on October 8, with the October VIX future trading at 20, while the VIX itself was at 18.77:

But by the time VIX futures hit their expiration, they must equal the actual VIX spot price — so if the VIX index is trading below the expiring future, the future will slowly drop to meet it.

Here’s the VIX futures curve on the day of October futures expiration:

On the morning of expiration, VIX opened at 15.8, which is where October futures expired.

And this constant gravity pulling on VIX futures means that products that track VIX futures — like my beloved ProShares Ultra VIX Short Term Futures ETF (Ticker: UVXY) — also trend lower in the long-term.

Yes, VIX pops will push VIX futures, and futures-tracking products, higher in the near-term, but long-term these things are pretty much hemorrhaging value.

And this is more or less what I expect to see out of BITO. 

Bitcoin futures trade at a premium to the cash value of actual bitcoin. While BITO will move with bitcoin on a day-to-day basis, in the long-term, BITO will likely underperform any upside seen by the actual cryptocurrency.

However … we are options traders, which means we have plenty of other ways to play and profit off this new ETF.

A Bitcoin For Your Thoughts

While BITO reached a trading volume of $1 billion during its first day of listing, BITO options were similarly heavily traded when they debuted on Wednesday.

The front-month BITO options were the most popular during the first day of trading, with the November 60-strike call seeing the most volume of any BITO options. However, the December contracts gained popularity later in the week.

Other contracts that saw notable first-day volume included the November 50-strike, 52-strike, 45-strike, 44-strike, 33-strike calls, and the December 60-strike calls (with between trading volumes between 3,400 and 2,400), and on the put-side, the 35-strike, 40-strike and 42-strike puts were most heavily targeted, with trading volumes of 2,169, 1,872 and 1,648, respectively.

Overall, about 70,000 contracts crossed the tape during BITO’s first day on the options market, with calls leading puts 5-to-2, and the pace of trading continued to pick up through the rest of the week.

Of course, like with most new options, BITO options were undoubtedly priced at a premium, so I think it’s likely buyers were way overpaying for what they were getting. Of course, Big Money was quick to advantage of this. Notably, on BITO’s second day in the pits, I saw a big strangle sale that brought in $2.4 million in premium to the seller.

While selling for premium during the early days of trading is definitely a tempting strategy, remember, bitcoin is volatile, and BITO will be, too. If you choose to sell options, make sure you aren’t getting in over your head should BITO take a quick trip lower (or higher). 

Of course, it seems many didn’t mind paying the “new pit premium” on BITO options, and by Friday, more than 100,000 contracts were changing hands. December calls were the most popular contracts crossing the tape, even as Bitcoin itself pulled back from all-time highs.

We also saw implied volatility (IV) begin to settle down just a touch, dropping from 95% on Wednesday to 75% by Friday. I expect we will see it continue to drop, as BITO options show us what they are really made of.

So, to sum up, remember: buy-and-hold BITO = bad!

BITO options = optimal (but they’re overpriced right now).

I believe playing the quick pops and drops on BITO will be a great way to rake in some money in the months ahead — but you MUST practice strict risk management if you want to trade what will almost certainly be a volatile ETF!

Your Only Option,

Mark Sebastian

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