BTC futures contracts, leverage effect, what is it?

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28 Dec 2017, 17:07

Let's look at the BTC futures contracts that Chicago Board Options Exchange (CBOE) and CME Group have been offering since December 2017.
Futures contracts allow traders to speculate on the price of an underlying asset (in this case, the price of Bitcoin), without having to hold that asset. Generate profits (or losses) by buying or selling such contracts, which will enable them to bet on developments in the price of Bitcoin. If a trader sells this contract, it is a "downsizing speculator", he expects the price of Bitcoin to fall, and aims to make money if this event happens. Conversely, if a trader buys this contract, we will say that it is a "speculator on the rise".
Even if a trader will necessarily have to buy a minimum number of contracts, we will use a simplified example, in order to understand how these futures work.

Let's take an example to understand more easily:

Imagine that Bob wants to buy a contract, and that the price of this contract is $ 50,000 (with a $ 10,000 Bitcoin course):
Before Bob can own this contract, he will have to deposit what is called an "initial margin". The initial margin is often presented as a "bona fide" deposit, or security deposit. It allows the trader to show that he is determined to respect the contract.
The initial margin represents a percentage of the total value of the contract. It usually amounts to around 10% of this amount.
Therefore, if Bob's initial margin is 10%, Bob will be able to obtain this contract once he has deposited at least $ 5,000 (10% of 50,000) into his trading account.
Now, suppose Bob deposits that $ 5,000 to buy the contract. He is therefore "speculator on the rise" - in other words, he expects the price of Bitcoin to exceed the price he paid for his contract ($ 10,000 per Bitcoin).
CME Group has put in place a minimum tick for Bitcoin, set at $ 5, which is the smallest change in the underlying asset that will be taken into account.
This means that if the Bitcoin price rises by $ 4, nothing will change for Bob: he will not make any profit or loss, since this amount is below the minimum tick. But if the price of Bitcoin increases by $ 5, Bob will earn $ 25 on his contract (since each contract is worth the equivalent of 5 Bitcoins).
The day after the purchase of the contract, the price of Bitcoin increases by 100 dollars - 20 ticks. Since Bob has a contract, the minimum tick is $ 5, and Bob earns $ 25 (5 * 5) for each tick, Bob will earn $ 500 on his contract (20 * 25 = 500).
Conversely, if the price of Bitcoin drops by $ 100 during the day, Bob will lose $ 500 - a sum that will be deducted from his trading account.

Talk about leverage, to multiply gains ... or losses.

Leverage: Remember: Bob paid only $ 5,000 to own a contract worth 5 Bitcoins ($ 50,000).

The $ 45,000 that Bob did not have to pay is actually a loan, in other words, Bob's investment is leveraged by 10. In fact, he managed to invest the equivalent of $ 50,000, with only $ 5,000 in bets.
This contract can therefore enable him to make a lot more money, if it's up, than if he had just bought Bitcoins. But this leverage will also multiply its losses, if the price of Bitcoin began to fall.

Now, imagine that four weeks after the purchase of the contract, the price of Bitcoin has increased by 5%, which corresponds to 500 "index points". After four weeks, Bob will have made a profit of $ 5 * 500 = $ 2,500.
He will have won 50% on his initial deposit. Indeed, he had deposited only 5000 dollars, and finds himself with 5000+ 2500, or $ 7,500 in his pocket. Had he just bought "directly" Bitcoins, he would have ended up with only 5,000 + (5,000 * 5%) = $ 5,250.

But conversely, if the price of Bitcoin decreases by 5%, Bob will have lost 2500 dollars, a 50% decrease on his investment.

The greater the number of contracts held by a trader, the more he or she takes risks. If the price of Bitcoin decreases significantly, Bob could lose more than the sums he had originally deposited.

Bob's initial investment was $ 5,000. If the price of Bitcoin decreased by 12%, or 1200 index points, Bob could suffer a loss of 5 dollars * 1200 = 6000 dollars.
His initial deposit of $ 5,000 will not be enough to cover this loss: he will have to pay $ 1,000 on his account to pay his debt to CME Group, and reset it to zero.
If Bob experiences a series of losses that reduce his security deposit to less than his "maintenance margin", the amount that must be available to keep open a margin transaction, he will receive a margin call. , whose purpose will be to replenish the security deposit that was started by the fall in the price of Bitcoin.

In order to limit the risks associated with the volatility of Bitcoin, CME Group has introduced limits on its futures contracts: at 7, 13 and 20%.

When the price of the contract evolves to +/- 7% of the settlement price - the price of Bitcoin at the close of the market, the day before - a "monitoring period" of two minutes will take place. The contracts can then always be exchanged, but without exceeding this "envelope" of 7%.

If at the end of this monitoring period, the price is still 7% above the closing price or 7% below, a "freeze" of a two-minute period will be put in place.

During this freeze period, traders will still be able to place orders - but these can not be executed until the end of this period.

The price limit will then be increased to 13%, with no freeze period, then to 20%, still without a freeze period.

But if the price of Bitcoin increases or decreases by more than 20% compared to the closing price recorded the day before, orders can not be executed during the rest of the day.

It should be noted that the initiative of CME Group is far from isolated, and that it is part of a trend marked by the arrival of institutional investors in cryptocurrencies - which could, according to some observers, bring more liquidity to the market and reduce the price volatility of Bitcoin.
The Chicago Board Options Exchange has indicated that it has applied for a Bitcoin futures contract. Nasdaq could also get started in the second quarter of 2018, when JP Morgan could offer its clients the contracts of CME Group, even as its CEO had recently said that Bitcoin was a "fraud".
We can also mention the arrival of many investment funds in cryptocurrencies (like the one that will be proposed by the French TOBAM), or the establishment of Coinbase Custody, from next year.

I hope you have enlightened on the subject that I want to admit it's not the most common and easy to understand, do not hesitate if you have questions;)

References: CoinTelegraph, Wikipedia, CME Group,

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