CBOE Bitcoin Shorts Got Ashdrake’d

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There once was a trader who went by the handle Lord Ashdrake. He was a Romanian programmer, and was a prolific force during the nuclear Bitcoin winter in 2014 and 2015. His skill was shorting Bitcoin, and that strategy worked like a charm until it didn’t.

When Bitcoin finally broke and held $300, Ashdrake performed his usual action of shorting Bitcoin. Unfortunately this time, the price continued through $300 to $500, and almost touched $600 in under 2 months.

He completely blew up his account to the point where he could no longer trade Bitcoin. His folly was being unable to shift into a bull market mindset. The trader community coined the term “to be Ashdrake’d.” It meant to completely blow up your trading account by shorting Bitcoin.

Leading up to Monday’s CBOE Bitcoin futures launch, the financial media constantly droned on that institutional investors would line up to short Bitcoin into the ground. However within twelve hours after the launch, the CBOE Jan Bitcoin future hit the circuit breaker three times, and was up over 20%.

Interactive Brokers was so afraid of being Ashdrake’d they did not allow clients to go net short the futures contract. They have since reversed that stance, but shorts must post a whopping 400% margin.

Contango, Anyone?

As I write this the CBOE future continues to trade at a premium to spot. There is a very simple reason why this future should usually trade at a premium.

Consider the plight of the average traditional active asset manager. Global central banks crushed volatility in all asset classes in their relentless drive to create inflation. Bonds, equities, ETFs, asset-backed securities are all prominently featured on central bank balance sheets.

Retail investors noticed. They realised en masse it is better to own a passive market-tracking ETF, than entrust an expensive human to generate “alpha”. Even the so-called smart money became glorified beta-chasers.

However, Bitcoin and other digital currencies continued to be volatile, have a negative correlation to risky assets, and go up in value. If I am an average active fund manager, I am surely underperforming a passive equity investment in the S&P 500, for example.

If I do nothing, I will certainly lose assets to passive ETFs with lower fees and better performance. However, I could swing the bat and import a call option with a negative correlation to my portfolio as a whole. If it goes to 0, who cares? I was going to underperform the index anyway. If it rises 50% to 100% in a month, I have added a few crucial basis points to my performance. That could be the difference between receiving a doughnut as a bonus or getting PAID.

That call option is going long Bitcoin futures. I don’t have to believe in Bitcoin, only its price, volatility, correlation, and liquidity. I don’t have to hold Bitcoin. I only need to use the USD already deposited with the CBOE or CME to trade the futures contract.

The specs will be net long Bitcoin futures contracts. The market makers who are delta neutral will sell futures and purchase Bitcoin. As I have said previously, market makers must receive a very high basis to compensate them for the USD margin they must post.

Unfortunately for these market makers, unrealised USD gains from being long Bitcoin cannot be used to offset the unrealised USD losses on their short futures position. Therefore the basis must be attractive enough to compensate for the large balance sheet usage.

The basis on the CBOE opened close to +10%, and now trades in the +3% to +5% range.

CME Game Time

All the traders I speak to unanimously prefer the CME’s contract structure to the CBOE’s. The main point of contention is that the CBOE uses only Gemini as a reference exchange. The liquidity of Gemini pales in comparison to the sum of Bitstamp, GDAX, itbit, and Kraken.

The CBOE launch on Monday whetted the appetite of speculators globally. Never before in my markets career have I seen such attention paid to a new futures contract.

The game has just begun, and the CME is going to rain 3’s like Steve Kerr all over the CBOE.

Out of the gate I expect the CME near month contract to hit the 7%, then 13% circuit breakers. By mid-morning Asia time, I expect the contract to be limit up at 20%.

Tame Bitcoin … Yeah, Right

Bitcoin is a wild bucking bronco, and the CBOE and CME lack the skills to ride 8 seconds.

We crypto traders should thank our lucky stars that these venerable exchanges decided to list futures contracts this year. The volatility and attention they have brought exceed anything I could have imagined.

Central banks saved commercial banks from certain death via aggressive money printing. However 9 years after the GFC, banks and investors are desperate for volatility. Bitcoin, altcoins, ICOs and all manner of digital tokens provide the long lost market gyrations that made generations of traders wealthy.

As Jesse Livermore said:

“I think it was a long step forward in my trading education when I realized at last that when old Mr. Partridge kept on telling other customers, “Well, you know this is a bull market!” he really meant to tell them that the big money was not in the individual fluctuations but in the main movements that is, not in reading the tape but in sizing up the entire market and its trend.”

Moral of the story: don’t get Ashdrake’d. BTFD, ya hearrd?