One of the most common and profitable trading strategies when trading futures is cash and carry. Traders employing this strategy buy underlying asset and sell its corresponding futures contract. They hold the futures contract until expiry, and profit from the differential between the future and underlying asset.
There are two types of BitMEX futures one can use to execute this strategy. XBU futures have very low risk and low reward. XBT futures have more risk but more reward.
Futures premiums can vary widely depending on the optimism in the market. Executed correctly and at the right time, a cash and carry strategy can lock in guaranteed profit.
We’ll delve into the XBU (5x) futures first.
Using BitMEX 5x Leveraged Futures (XBU)
BitMEX offers a series of futures contracts that have 5x leverage. That means a trader who deposits 10 BTC can control a position worth 50 BTC. These contracts we classify as Hedging, and use the symbol prefix XBU. The contracts are worth $100 of Bitcoin. Put another way, no matter what the BTCUSD exchange rate is, the contract will equal enough Bitcoin such that its value is $100.
The below example will run through the mechanics and risks of a cash and carry strategy using these futures contracts.
Spot Bitcoin price = $200
March 2016 futures price = $250
Cash and carry profit = $50/Bitcoin
A trader will now buy spot Bitcoin and sell March 2016 futures contracts.
Assume the trader has $10,000. He buys 50 Bitcoin at a price of $200. He then must sell enough March futures contracts to hedge his long exposure.
March 2016 Futures Contracts = $10,000 / $100 = 100 Contracts
| Quantity | USD Value | Bitcoin Value | |
| Spot | 50 BTC | -$10,000 | 50 BTC |
| March 2016 Futures (XBU) | -100 | $10,000 | -50 BTC |
| Total Exposure | $0 | 0 BTC |
The trader has locked in a risk free profit of $2,500 regardless of the subsequent BTCUSD exchange rate. The below example will illustrate why.
Assume that the spot price rises to $250. The below table shows the change in the USD and Bitcoin value of the spot and futures positions.
| Quantity | Price | USD Value | Bitcoin Value | PNL | Total USD Value | Total BTC Value | |
| Spot | 50 BTC | $250 | -$12,500 | 50 BTC | $2,500 | -$10,000 | 50 BTC |
| March 2016 Futures (XBU) | -100 | $250 | $10,000 | -40 BTC | -10 BTC | $10,000 | -50 BTC |
| Total Exposure | $0 | 0 BTC |
The trader makes USD PNL on the long spot position, and BTC PNL on the short futures position. The net effect is the total portfolio exposure does not change. Because the trader bought spot at $200 but sold futures at $250, he has actually profited the difference and no price movement will change that.
Assume that the spot price falls to $150. The below table shows the change in the USD and Bitcoin value of the spot and futures positions.
| Quantity | Price | USD Value | Bitcoin Value | PNL | Total USD Value | Total BTC Value | |
| Spot | 50 BTC | $150 | -$7,500 | 50 BTC | -$2,500 | -$10,000 | 50 BTC |
| March 2016 Futures (XBU) | -100 | $150 | $10,000 | -67 BTC | 17 BTC | $10,000 | -50 BTC |
| Total Exposure | $0 | 0 BTC |
The trader makes USD PNL on the long spot position, and BTC PNL on the short futures position. The net effect is the total portfolio exposure does not change.
Once a trader has bought spot and sold futures contracts, there is nothing else to do but wait until expiry. This is a pure cash and carry strategy. For this reason, the XBU (5x leveraged futures) premium to spot will be much less than the XBT (25x leveraged futures) premium to spot.
Using BitMEX 25x Leveraged Futures (XBT)
BitMEX’s other Bitcoin futures have 25x leverage. That means a trader who deposits 10 BTC can control a position worth 250 BTC. These contracts we classify as Speculative, and use the symbol prefix XBT.
XBT contracts are differently structured. The contracts pay out 0.00001 BTC per $1 movement of the BTCUSD price. Put another way, if the BTCUSD prices rises by 1% the Bitcoin value of the futures contract rises by 1%. All profit and loss for the futures contract is paid out in Bitcoin.
The below example will run through the mechanics and risks of a cash and carry strategy using these futures contracts.
Spot Bitcoin price = $200
March 2016 futures price = $300
Cash and carry profit = $100/Bitcoin
A trader will now buy spot Bitcoin and sell March 2016 futures contracts.
Assume the trader has $10,000. He buys 50 Bitcoin at a price of $200. He then must sell enough March futures contracts to hedge his long exposure.
Given no volatility, the trader would profit 50 * ($300 – $200) or $5,000. But there will be volatility, so there are some considerations.
March 2016 Futures Contracts = 500 BTC / ( $200 * 0.00001 ) = 25,000 Contracts
We use the spot price of $200 to calculate the number of contracts to hedge instead of the futures price of $300. This is because you are holding the future until maturity, so it should be valued at the spot price.
| Quantity | USD | Bitcoin | |
| Spot | 50 BTC | -$10,000 | 500 BTC |
| March 2016 Futures (XBT) | -25,000 | $10,000 | -500 BTC |
| Total Exposure | $0 | 0 BTC |
Because of the return profile of the futures contract, this trade is not risk free.
Assume that the spot price rises to $250. The below table shows the change in the USD and Bitcoin value of the spot and futures positions.
| Quantity | Price | USD Value | Bitcoin Value | PNL | Net USD PNL | |
| Spot | 50 BTC | $250 | -$12,500 | 50 BTC | $2,500 | $2,500 |
| March 2016 Futures (XBT) | -25,000 | $250 | $15,625 | -63 BTC | -13 BTC | -$3,125 |
| Total Exposure | $3,125 | -13 BTC | -$625 |
To flatten the exposure to 0, the trader would need to buy 13 BTC at a price of $250. In addition, he is locking in a loss of $625.
Assume that the spot price falls to $150. The below table shows the change in the USD and Bitcoin value of the spot and futures positions.
| Quantity | Price | Value | Bitcoin Value | PNL | Net USD PNL | |
| Spot | 50 BTC | $150 | -$7,500 | 50 BTC | -$2,500 | -$2,500 |
| March 2016 Futures (XBT) | -25,000 | $150 | $5,625 | -38 BTC | 13 BTC | $1,875 |
| Total Exposure | -$1,875 | 13 BTC | -$625 |
To flatten the exposure to 0, the trader would need to sell 13 BTC at a price of $150. In addition, he is locking in a loss of $625.
Due to a long spot vs. short futures position, as the price moves the trader must buy high and sell low to have no exposure to the Bitcoin price. Every time he hedges his portfolio he is losing money, meaning he is short volatility. If the price moves too much between now and March 2016, the cost of hedging his portfolio will outweigh the premium earned by selling the future above the spot price.
By employing this cash and carry strategy, the trader is selling volatility for a premium. To determine the trader’s break even volatility, we must solve for the upper and lower bound where the trade ceases to become profitable.
Solving the following quadratic equation will give the upper and lower bound
F = Future Price, in this example $300
S = Spot Price, in this example $200
Sqrt = Square Root
Upper Bound:
[ -2 * F – Sqrt( 4 * F^2 – 4 * S * F ) ] / -2
In this example, $473.21.
Lower Bound:
[ -2 * F + Sqrt( 4 * F^2 – 4 * S * F ) ] / -2
In this example, $126.79.
Assume there are 180 days until the March 2016 future expires. That means the trader sold volatility at this level:
( $473.21 / $126.79 -1 ) * Sqrt ( 365 / 180) = 386.40% Annualised Volatility
If the trader rebalanced his portfolio once daily, the price would have to move at greater than a 386.40% annualised volatility for the trader to lose money. For each day that the realised volatility is lower than 386.40% annualised, the trader makes money. This is the daily carry that he earns.
Summary
Cash and carry is a valuable strategy that can lock in great returns.
On BitMEX, cash and carry strategies using XBU have no price risk. For this reason, expect XBU contracts to have less premium over spot.
Doing cash and carry arbitrage on the XBT series carries more risk, but may have much more reward.