Bitcoin Futures Basis Trading: Lesson 3

In the third and final lesson, I will explain some basic risk management policies relating to basis trading. First I will explain the risk management metrics Delta, Bitcoin Value of 1% (BV01), and Theta. For each of these metrics, I will always present them in Bitcoin terms.

Delta

The performance of a Bitcoin futures contract is made up of three components, spot, interest rates, and time. The delta of a portfolio of Bitcoin futures contracts refers to the portfolio’s exposure to the movements in the spot price.

Delta = Spot Price * BTC Multiplier * Contracts

For example a the December 2015 25x leverage Bitcoin / USD futures contract (XBTZ15), settles on the TradeBlock XBX Index price. The current value of the XBX Index price is the spot price for XBTZ15.

Assume the following:

Spot = $250

BTC Multiplier = 0.00001

Contracts = 100,000

XBTZ15 Delta = $250 * 0.00001 BTC * 100,000 Contracts = 250 BTC

Because the portfolio is long, if the spot price moves up 1%, the profit is 2.5 BTC. If the spot price moves down 1%, the portfolio loses 2.5 BTC.

Delta PNL (Profit and Loss) = % Change in Spot * Delta

Notice that we use the spot price not the current price of the futures contract to calculate delta. The basis or difference between the spot and futures price is expressed through the BV01 and Theta metrics.

Bitcoin Value of 1% (BV01)

The BV01 refers to the amount that will be made or lost if the interest rate changes by 1%.

t = Days to Expiry / 360

% Basis = (Futures Price / Spot Price – 1) / t

BV01 = 1% * t * Spot Price * BTC Multiplier * Contracts

Assume the following:

Spot = $250

BTC Multiplier = 0.00001

Contracts = 100,000

t = 0.5

BV01 = 1% * 0.5 * $250 * 0.00001 BTC * 100,000 = 1.25 BTC

If the % basis rises by 10% in annualised terms:

BV0L PNL = 10 * 1.25 BTC = 12.5 BTC

Theta

Theta is the amount of money that a portfolio will gain or lose as time passes. Because a futures contract will equal the spot price at settlement, each day the basis between the future and spot price will get smaller.

Basis = Future Price - Spot Price

Depending on whether the basis is positive or negative a long or short futures position will have a positive or negative Theta. When calculating Theta multiply the result by -1 to get the correct result. Below is a table summarising in which situations Theta is positive or negative.

Futures Position Basis Theta
Long Positive Negative
Short Positive Positive
Long Negative Positive
Short Negative Negative

Theta = (Basis / Days Until Expiry) * BTC Multiplier * Contracts * -1

Assume the following:

Spot = $250

XBTH16 = $300

BTC Multiplier = 0.00001

Contracts = 100,000

Days = 180

Basis = $300 - $250 = $50

Theta = ($50 / 180 Days) * 0.00001 BTC * 100,000 * -1 = -0.28 BTC

Putting It All Together

Let’s construct a sample portfolio and examine the interplay between Delta, BV01, and Theta. The futures term structure is in contango and a trader wants to earn the carry between the December 2015 and March 2016 futures contracts.

Symbol Contracts Spot Price Days t Multiplier % Basis Futures Price Basis BTC Delta BTC Theta BV01
XBTZ15 100,000 $100 30 0.25 0.00001 BTC 100% $125 $25 100 BTC -0.83 BTC 0.25 BTC
XBTH16 -100,000 $100 180 0.5 0.00001 BTC 200% $200 $100 -100 BTC 0.56 BTC -0.50 BTC
Total 0 BTC -0.28 BTC -0.25 BTC

To properly evaluate whether this is a good trade or not, let’s consider a few scenarios.

Scenario 1:

XBTZ15 is held until maturity, and the % basis does not change.

The portfolio will lose money due to the negative Theta.

30 days * -0.28 BTC Theta = 8.4 BTC loss

Scenario 2:

XBTZ15 is held until maturity, and a parallel shift in the % basis.

The % basis will need to parallel shift downwards by 33.60% for the portfolio to break even due to the Theta loss.

8.4 BTC / 0.25 BTC BV01 = 33.60% change in interest rates

If the % basis parallel shifted upwards, the portfolio would lose money both on the Theta and the BV01.

Scenario 3:

The term structure changes and you intend to exit the position before XBTZ15 expires.

Daily Curve PNL = Portfolio Theta + XBTH16 BV01 PNL + XBTZ15 BV01 PNL

If the % basis differential widens (a curve steepener) in any magnitude, you have an unrealised loss from BV01 and Theta. If the % basis differential narrows (a curve flattener), you have an unrealised gain if the BV01 profit is greater than the daily Theta loss.

The below is a table shows the Daily Curve PNL depending on changes in the % basis differential.

XBTH16
XBTZ15 % Basis Change -2% -1% 0% 1% 2%
-2% 0.22 BTC -0.28 BTC -0.78 BTC -1.28 BTC -1.78 BTC
-1% 0.47 BTC -0.03 BTC -0.53 BTC -1.03 BTC -1.53 BTC
0% 0.72 BTC 0.22 BTC -0.28 BTC -0.78 BTC -1.28 BTC
1% 0.97 BTC 0.47 BTC -0.03 BTC -0.53 BTC -1.03 BTC
2% 1.22 BTC 0.72 BTC 0.22 BTC -0.28 BTC -0.78 BTC

Basis trading is a bit more complicated than out right position trading. However, due to the lack of understanding by many Bitcoin traders about the interplay between time and interest rates as it applies to Bitocin futures contracts, there are many more opportunities to earn above average risk adjusted profits.