Cash and carry arbitrage is a staple strategy for traders seeking high risk adjusted returns. Because Bitcoin can go to infinity but only fall to zero, speculators at the margin are buyers. Add in 100x leverage, and bullish speculators are willing to pay very high per annum interest rates to go long Bitcoin for short periods of time.
Cash and Carry Step by Step:
- Buy $1,000 worth of Bitcoin at $2,000
- Sell 1,000 BitMEX futures contracts, e.g. XBTM17, at $2,500
- Wait until expiry, and collect $500 of profit
Given the current rally, the BitMEX Bitcoin / USD 30 June 2017 futures contract, XBTM17, has traded at a premium (or a positive basis) for almost the entire length of the contract. Traders who sell futures and buy Bitcoin essentially earn a fixed rate of return until expiry to lend long speculators synthetic USD.
To earn the full premium, you must keep the trade on until expiry. However, while arbitrageurs are making good money from this strategy, they are leaving food on the table.
The above chart plots the hourly annualised premium of XBTM17. It is immediately apparent that the premium itself is very volatile. The premium takes the stairs up, and the elevator down.
For traders already comfortable with cash and carry arbitrage, it is time to add a mean reversion strategy to your toolkit. Below are the relevant statistics for the data sample:
While you can’t pick the lows and highs, in general terms you can put on positive carry trades during times of extreme stress and close out when the premium normalises. That allows you to increase your returns during the contract period.
Recently the XBTM17 premium traded over 100% p.a., then a few days later traded at a discount. Instead of waiting another 20 days until expiry, arbitrageurs actively trading the basis could realise the entire 100% return in under 24 hours.
A simple yet effective strategy is what I call the Stair Step Cash and Carry Arbitrage. Assume that a normal range for the premium for a quarterly contract is 0% to 60% p.a. As the premium rises, at each 10% interval I will sell 10,000 XBTM17 contracts and buy $10,000 worth of Bitcoin. If the premium hits 60%, my expected return on $60,000 should I hold until expiry is 35% p.a.
If the premium falls from 60% to 0%, I will buy back 30,000 XBTM17 contracts and sell $30,000 worth of Bitcoin at every 30% increment. The key point is that at all times I have a portfolio with positive carry, and I benefit from volatility in the premium.
You can get very sophisticated about how you choose your increments and sizing of trades. The more granular your steps, the more profit you can harvest from the volatile premium.