(MarketWatch)-After a week of slow but steady trading on Cboe Global Markets, a new player is set to enter the bitcoin futures market on Monday.
CME Group Inc. CME, +0.43% the world’s largest futures exchange, is set to introduce its bitcoin contract, trading under the symbol “BTC.” Cboe January bitcoin futures XBTF8, +7.68% settled at $18,105 on Friday, a daily gain of 8% and a rise of around 21% from the contract’s opening trade at $15,000 on Sunday evening. Cboe CBOE, +0.25% said 1,515 January contracts changed hands Friday.
Cryptocurrency enthusiasts contend the introduction of futures trading will attract institutional and professional traders, lending legitimacy to a volatile market, which has attracted the spotlight with soaring prices BTCUSD, +2.54% that have spurred numerous warnings of a potential bubble.
Here are some basics that traders and investors need to know about bitcoin futures:
A futures contract allows a trader to place a leveraged bet on whether the price of the underlying asset will move higher or lower before the contract expires. A trader who thinks the price will rise can go “long,” while a trader who expects the price to fall can go “short.” In futures, there is a short bet for every long and vice versa.
Cboe and CME bitcoin futures are cash settled, meaning no bitcoins will actually change hands when a contract expires. Winning traders effectively collect their gains from the losers. As with most contracts, traders will likely have closed out positions, collecting gains or ceding losses, before expiration.
There are some differences between the CME and Cboe contracts.
The CME contract, for one, is bigger, consisting of five bitcoin to one for the Cboe contract
The ability to place a short bet without having to first borrow the underlying security is one of the appeals of the futures market. Investors hope it will make for more efficient price discovery, helping to tame the extreme volatility that regularly whipsaws the bitcoin market.
It’s also seen as a boon for bitcoin bears, who have been frustrated by the technical difficulty inherent in shorting bitcoin.
Modest volume, however, may reflect a reluctance by potential shorts to enter the market, said Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, a financial analytics firm, in a note earlier this week.
“Thin trading volumes would hinder short exit strategies; short sellers rarely ‘fight the tape’ and prefer not to try and accumulate short exposure in rallies; several brokers were only facilitating long futures buying and not short futures selling; some brokers are waiting several trading days before transacting and settling any bitcoin futures trades; and the cash settlement of the contract hindered arbitrage trading,” he said.
But futures got a vote of confidence Friday from online broker TD Ameritrade, which said it would open trading in the Cboe contract, saying the firm believes “the market is showing signs of adequate liquidity for the Cboe product.”
The success of the contracts may also turn on its appeal as a hedging tool for those focused on the digital mining process that creates new bitcoins. Indeed, the big players in the market, dubbed “bitcoin whales” in this Bloomberg article, may be particularly interested in the ability to hedge against the possibility of a sharp price fall via the futures markets.
And some professional futures traders “are licking their chops for the opportunity to unleash their quantitative trading systems on the bitcoin market,” said Matt Osborne, chief investment officer at Altegris, a La Jolla, Calif.-based provider of alternative investment products with $2.5 billion in assets under management, in a Dec. 8 interview.
But that’s going to take time, he said, as they will need price history data on which to build systems.
On the downside, it’s hard to ignore the reservations expressed by big banks and brokers, who had criticized the futures launch as premature. In an open letter to the Commodity Futures Trading Commission, the Futures Industry Association said the exchanges didn’t get enough feedback on margin levels and other considerations.
Margin is the amount of money a trader must initially pony up as collateral when taking a futures position. For many heavily traded contracts, the margin amount is under 10% of the total value of the underlying contract.
The initial margin, the amount of collateral a trader must put up to trade a contract, is set at 43% for the CME contract versus 44% for the Cboe contract. Margin levels are subject to change and, due to bitcoin’s volatility, are much higher than for popular futures contracts.
In the case of Cboe, that means if the contract was trading at $15,000, a trader wishing to go long or short would have to put up $6,600. He would be subject to additional margin calls if the margin account falls below a certain level.
The high margins reflect concerns about the underlying volatility of bitcoin BTCUSD, +2.54% which this week alone saw large price swings, at one point rallying around 40% in less than two days as it soared to new highs.
Like most futures contracts, bitcoin futures are subject to limits on how far prices can move before triggering temporary and permanent halts. The Cboe contract saw trading halts in the past week. It’s subject to a two-minute halt if the best bid in the contract closest to expiration moves 10% above or below the previous day’s close.
If, after trade resumes, the contract moves 20% or more above or below the previous day’s settlement, trade will be halted for five minutes.
The CME contracts will be subject to daily price fluctuation limits of 7%, 13% and 20% to the upside or downside. If the lead month contract hits the 7% or 13% limit, trading will continue but will be required to remain within the price limit for a two-minute period. If the contract comes off the limit before the end of the two-minute period, trade will continue without a halt at the expanded limit of either 13% or 20%. If the contract, however, is still at the limit at the end of the monitoring period, there will be a two-minute halt, after which trade will resume at the expanded limit of 13% or 20%.
If prices hit the 20% limit, however, there will be no trading halt and price limits won’t expand, the CME said. Instead, trading will continue within the 20% limit for the remainder of the trading session.
Institutional investors and professional traders are likely to “tiptoe” into the futures market, Osborne said. But what about retail investors who might be tempted to dip their toes in?
“Bitcoin is volatile enough as a stand-alone investment. I don’t think the retail investor needs to be adding to leverage through a futures contract on top of bitcoin,” Osborne said. “So buyer be very much beware when it comes to retail investors and futures contracts.