Using CBOE Bitcoin Futures To Predict Underlying Bitcoin Price Direction – Winklevoss Bitcoin Trust ETF (Pending:COIN)

By Zhuoqi Gao, Robert Annis, and Xin Jiang

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Due to increasingly bullish positions being taken in Bitcoin futures, we believe investors have speculated an end to the Bitcoin price decline, and we should see an increase in Bitcoin pricing going forward. In recent months, there has been considerable public interest, discussion, and speculation over the cryptocurrency market and what the future holds for it. Arguably, sitting at the forefront of these conversations is Bitcoin. Bitcoin is a digital currency or, as it’s better-known, cryptocurrency which was created in 2009. It was originally established by Satoshi Nakamoto, a programmer whose identity is still unknown to this day. The characteristics of the cryptocurrency are unlike any traditional fiat currency such as the dollar, euro, or yen which have created value through their individual governing entities. Rather, Bitcoin is not backed by any country’s central bank or government and is controlled by a peer-to-peer network which is implemented worldwide. This technology known as blockchain allows for a lack of central authority over Bitcoin. This relatively new technology is accomplished through a public ledger of all transactions where each block contains a piece of the previous ones allowing for increased transaction speed and reduced potential for fraud. Overall, the popularity of Bitcoin has increased substantially with nearly 16.9 million Bitcoin in circulation as of March 3, 2018, a 4.3% increase over March 3, 2017.

Because of the growing interest in Bitcoin, in December 2017, futures contracts on Bitcoin were introduced. Bitcoin futures allowed investors to speculate on where the underlying price would be at a later date in time, and attempt to profit on this. The Chicago Board of Exchange (CBOE) was the first institution to implement these futures contracts on December 10, 2017. This launch was closely followed by the Chicago Mercantile Exchange (CME), a close rival with CBOE which launched its own Bitcoin futures option just over a week later.

We believe though the underlying price of Bitcoin is not impacted directly by these futures contracts, the underlying price direction of Bitcoins can be speculated by looking at the respective long and short positions within these contracts. As a result, we believe given the increased bullish position in Bitcoin futures, investors believe we have seen the bottom of the Bitcoin decline and should see an increase in Bitcoin pricing going forward. With this said, due to the potential of unforeseen events such as regulation, investors must be very cognizant of trends and news relating to Bitcoin. To better understand this viewpoint, we will look at the fundamentals of Bitcoin futures, Bitcoin volatility, and the analysis of the underlying investor perspective on future Bitcoin direction through the bull/bear ratio. It’s important to note for the purposes of this article, we will only be analyzing the CBOE futures contracts as CME data is yet to be available through the Commodity Futures Trading Commission (CFTC).

Bitcoin Futures

The underlying price and daily settlement for CBOE Bitcoin futures are based on the Gemini Exchange Auctions value for Bitcoin. The settlement of these contracts is done on a cash basis where the underlying Bitcoin on which the contract is valued is not actually delivered. Rather, the gains or losses incurred by the trader are simply paid in cash to avoid having to establish a Bitcoin wallet to trade in futures. Because of the severe volatility incurred within Bitcoin, the margin requirements to trade in these futures are very high. To trade a Bitcoin futures contract with CBOE, an investor is required to post a 44% margin. Comparatively, with heavily traded futures contracts, the requirements can be 10% or below.

Bitcoin Volatility

Source: Bitfinex Historical Data

In the above graph, we can see the significant volatility in Bitcoin prices which we have experienced in the time period from December 13, 2017, through February 27, 2018. The blue line represents the daily change percentage experienced at market close each day. Over this time period, price fluctuations have varied dramatically with a maximum daily percentage increase of 15.1% on December 26 and a maximum decrease of 18.4% on January 16. Overall, when averaged over the entire course of the time period, Bitcoin experienced a decline of .33% per day.

CBOE had its first contract expiration for Bitcoin futures occur on January 17, 2018. Going on this date, the bull/bear ratio was 73.9% representing a 3% decline from the ratio as of January 9. This indicated, that more investors were speculating that Bitcoin prices were…

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