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An essential concept for a commodity trader is contango and backwardation, which describe term structure or the price difference for delivery in one period vs. another.
Contango is a state where the price for nearby delivery is lower than that for deferred delivery. The higher deferred delivery price often reflects the impact of interest rates, storage, and other factors. Contango markets tend to be in equilibrium or surplus in the raw materials world.
Backwardation is the converse, where prices for deferred delivery are lower than for nearby delivery. Backwardation often reflects tight supplies or a market deficit. In commodities, high nearby prices often cause production to increase and demand to decline, causing lower deferred prices.
The 2x Bitcoin Strategy ETF product (BATS:BITX) applies the contango and backwardation concepts to the leading cryptocurrency futures as the product moves higher and lower with one-day futures rolls from the nearby to the next active month CME Bitcoin futures contracts. Moreover, BITX is an example of how crucial it is to understand the products we consider for our portfolios.
Bitcoin eclipsed the late 2021 high
Bitcoin exploded to new highs in early March 2024.
Spot Bitcoin Chart From 2010 (Barchart)
The long-term chart highlights the more than 350% rally from the November 2022 low of $15,516.53 to $72,789.79 on March 11, 2024. Bitcoin moved above the November 2021 high of $68,906.48 into uncharted territory in early March 2024.
Historical volatility and interest rates have increased
Historical volatility measures an asset’s price variance.
Six-Month Bitcoin Chart with Historical Volatility (Barchart)
The chart illustrates Bitcoin’s historical volatility rise from 31.76% on Feb. 20, 2024, to 56.91% on March 12. Increasing volatility means the daily trading ranges have widened.
Ten-Year Chart of the 30-Year U.S. Treasury Bond Futures (Barchart)
The U.S. 30-year Treasury bond futures chart shows a bearish trend of lower highs and lower lows since the March 2020 highs. At the 120-24 level on March 12, the long bond was closer to the 16-year October 2023 107-04 low than the March 2020 peak. Higher interest rates and historical volatility cause spreads between many assets’ future delivery months to widen.
Forward Curve for CME Bitcoin Futures (CQG )
The chart illustrates the contango on March 8 that created higher prices for Bitcoin futures for deferred delivery months. Higher interest rates tend to push the spreads higher.
BITX offers leverage to the daily Bitcoin futures spread – not the crypto’s price
BITX is a novel product. The Fund Profile states:
Fund Profile for the BITX ETF Product (Seeking Alpha)
A more detailed explanation of how BITX works is available on the volatilityshares.com website:
Explanation of the BITX ETF Product (volatilityshares.com)
BITX exists to allow for cash and carry arbitrage for hedging purposes. “Cash and carry arbitrage” is a financial strategy that involves exploiting the mispricing between an underlying asset and a financial derivative, in BITX’s case, between spot Bitcoin and Bitcoin futures trading on the Chicago Mercantile Exchange.
Significant liquidity
The significant liquidity in BITX is a testament to its success as a financial arbitrage product. At the $55.80 per share level on March 12, BITX had $1.20 billion in assets under management, with over 3.7 million shares on average changing hands daily. BITX charges a 1.85% management fee.
BITX is a short-term product that professional arbitrageurs use to capture significant mispricing between the futures and the spot market. Extreme volatility in Bitcoin can create mispricing and arbitrage opportunities.
A very short-term product for arbs – the price of leverage
BITX is a new product that began trading in June 2023.
BITX opened for trading on June 27, 2023, at $15.57 per share. On that day, spot Bitcoin opened at $30,163.32 per token, and the current active month March 2024, CME futures contract at $32,285 per token. The higher price for the March contract was a function of the premium for future (nine-month) delivery.
One-Year Chart of the BITX ETF Product (Barchart)
The BITX chart shows it dropped 41% to a $9.18 per share low on September 11, when spot Bitcoin fell 17.2% to $24,963.04 per token, and March Bitcoin futures dropped 18.9% to $26,185 per token.
Meanwhile, the spread between spot and March Bitcoin moved from $2,121.68 to $1,221.96, falling 57.6% over the period.
The rally from the Sept. 11 low took spot Bitcoin to a $72,789.79 high on March 11, with the March Bitcoin futures reaching $73,775 spot rallying 191.6%, with Bitcoin futures moving 181.7% higher. While Bitcoin trades around the clock, Bitcoin futures only trade during CME trading hours. Moreover, BITX only trades during U.S. stock market hours. BITX moved to a $59.51 high on March 13, a 548.3% rally from the Sept. 11 low.
Meanwhile, BITX’s significant rally has little to do with the moves in spot Bitcoin and Bitcoin futures, but with the arb between the spreads between the price of the nearby month and the next month’s price daily. Moreover, BITX is double leveraged, reflecting the contango of the forward premium of two Bitcoins.
BITX is an interesting product, and its chart and trend look like a runaway bull market. However, this product is only appropriate for professional traders with arbitrage risk between the futures and spot market. Other market participants will struggle to understand the risk of the product that looks like another Bitcoin derivative, while its real leveraged exposure is the cash and carry arbitrage spreads. Investors and traders without significant experience should avoid this product like the plague and leave it for the professionals.
BITX is an example of a product that requires a unique skill set and reminds us that reading and understanding disclosure documents is critical for success.
