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Crypto Trader Digest

October 20, 2014
Arthur Hayes
Co-Founder & CEO

BitMEX Happenings

The BitMEX public testnet is now live. Using Testnet Bitcoin you may now place orders on our testnet exchange. This is a great way to configure your auotmated trading stratgies before BitMEX goes fully live in the coming weeks.

The BitMEX team competed and won the Slush HK startup pitch competition. We will now be attending the Slush conference in Helsinki on November 18-19th. BitMEX will also have a booth at TEDx Hong Kong on November 15th.

View the Forbes article about our Slush HK victory.

XBT Spot

The Bearwhale was slaughtered at $300 and XBT furiously rebounded to over $410. The chart above shows the 7- and 30-day moving average of the BME Index. The 7d MA has recently crossed the 30d, which signals the beginning of a short-term bull market. If XBT can hold $400 for 24 hours, the price will rise to $430-$450. At $450 expect a possible pullback to below $400.

The Bearwhale's 30,000 XBT $300 limit sell order on Bitstamp brought forth many calls for more regulation of how Bitcoin exchanges operate. As is always the case, when traders start losing money the calls for some intervention to rescue their PNL becomes louder. Only when one has lost money is it clear whether one prefers to suckle on the teat of Ben Lawsky, or become a cryptocurrency cowboy. Some cry "manipulation", but Bitcoin is one of the last bastions of free market capitalism. Two of the world's most important asset markets are hopelessly rigged. The Federal Reserve uses three methods: its quantitative easing program (money printing), the repo market, and the Federal Funds Rate, all to manipulate the price of money to the detriment of 99.99% of the world's population. High frequency trading firms legally front run investors in the US equity markets, and it has been statistically shown that members of US congress earn above average profits on companies in industries they regulate. This is commonly referred to as insider trading, but status has privileges. Bitcoin does not suffer from these disadvantages.

Trade recommendation:

Go long XBT with a near-term price target of $430 - $450.


Above is a chart showing how the XBTUSD interest rate curve has moved over the past two weeks. Short-term rates have spiked making the curve inversion worse. Overall, there has been a slight parallel shift upwards in basis. A strategy of buying futures contracts and short selling XBT has shown a slight profit.

The 6 month basis has yet to move upwards in a meaningful way. Longer dated futures contracts are trading very cheap. Selling shorter dated futures contracts and buying longer dated ones will profit as the curve normalizes. On BitMEX, trading buying calendar spreads will achieve the same result.

Trade Recommendation:

Go long a calendar spread: ideally a 1 month vs. 6 month. As 6 month rates rise, the trade will show a profit. The 6 month futures contracts contains much more time value or theta, which provides the horsepower behind the trade.

BitMEX XBTUSD Skew Index

Using the implied volatility (IVOL) data obtained from the BitMEX Totem marks, we have created the BitMEX XBTUSD Skew Index. Skew measures the degree to which OTM Call IVOL is different to that of OTM Put IVOL.

  Skew = 120% Strike Call IVOL - 80% Strike Put IVOL

The chart above displays the skew index for 1M, 2M, and 3M option maturities. If skew is negative that means that OTM puts have a higher IVOL than OTM calls. During the recent correction below $300, skew fell considerably. Traders fearful of the downside were willing to pay more for the downside protection that put options provide. The fearfulness manifests itself through higher IVOL marks. The 3M skew wasn't affected to such a degree by the price fall, as longer dated options are less sensitive to short term price fluctuations.

If you believe that XBT has bottomed out and want to participate on the upside, a good trading strategy would be to sell 80% strike puts and buy 110% strike calls. You will receive premium income from selling 80% puts that are trading more expensive in IVOL terms than 110% calls. The benefit of this strategy is that you can cheapen the price of your call options. Using the Black Scholes formula I have priced up this options structure. The at the money forward (ATMF) is priced using the BitMEX Totem XBTUSD NDF interpolated 40 day basis of $9.79, or $399.79 outright [$390 Spot + $9.79 Basis]. A risk free interest rate of 5% is used. A November 28, 2014 $440 Call option with an IVOL of 65% costs $19.26. A November 28, 2014 $320 Put option with an IVOL of 79% costs $10.16. Below I have listed the option greeks, for more information about the greeks please consult Wikipedia.

  Action: buy 1 call, sell 1 put
  Cost: $19.26 - 10.16 = $9.10 or 2.28% [$9.10 Premium / $399.79 ATMF]
  Delta: 0.3658 - -0.1622 = 0.528
  Gamma: 0.0044 - 0.0024 = 0.002
  Vega: 49.60 - 32.42 = 17.18
  Theta: -0.4204 - -0.3535 = -0.0669
  Rho: 0.1391 - -0.0822 = 0.2213

By selling the put, the effective cost of the structure has been halved. You pay 2.28% to gain upside exposure with greater leverage. As XBT spot increases, the call option becomes more valuable and the put becomes further OTM. There is a greater chance that the put will expire worthless and you will be able to pocket the full premium received. If spot falls, the call is worth less, and the put is closer to expiring ITM. If the put expires ITM, you must receive XBT and pay $320 regardless of where spot is trading on that day.

Trade Recommendation:

Buy November 28, 2014 110% strike calls, sell 80% strike puts. Do so in a 1:1 ratio.

XBTUSD Volatility Surface

Above is the volatility surface using October 13, 2014 BitMEX Totem IVOL marks.

Commercial Hedging with BitMEX

BitMEX is not just meant for professional traders looking for ways to earn alpha. We are also the exchange where businesses can effectively hedge their Bitcoin vs. fiat currency risk. In the upcoming newsletters, I will explain different hedging strategies that can be employed using BitMEX derivative contracts.

An example:

A shoe merchant has a new client who would like to pre-order a large quantity of shoes and pay in Bitcoin upon delivery. The merchant must produce the shoes before they receive the Bitcoin payment. The merchant's production costs are denominated in USD. Now the merchant has short USD vs. long XBT currency risk until client pays for their order. The merchant cannot sell XBT on the spot market, as they don't have the coins yet. The merchant can trade a futures contract on BitMEX to hedge this risk.

The value of the order is $100,000. BitMEX offers a USD futures chain, where each contract is worth a fixed 10 USD and is quoted in XBt.

  1 XBt = 1 Satoshi = 10^-8 XBT

Profit and loss are paid out in XBT depending on the level of USDXBt. The merchant is short USD vs. long XBT, or short USDXBt. They will receive payment on November 28, 2014, so they must buy the USDX14 futures contract. Given each contract is worth a fixed $10, they need to purchase 10,000 contracts.

Currently XBTUSD spot is $400, so the merchant will receive 250 XBT. The USDX14 contract trades at 250,000 XBt or $400 if the underlying was XBTUSD [1/$400 * 10^8]. The above table shows that no matter where USDXBt trades at the end of November the value of the merchants portfolio in USD terms is $100,000.

For more information about how to hedge using BitMEX, please read the BitMEX blog post BitMEX for Commercial Hedgers. Here is a link to a public Google spreadsheet if you have further questions about these calculations.
Data sources: Investing.comBitcoinity

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