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How to Trade Bitcoin Without Actually Owning Bitcoin

Source: iStock/Traitov

On December 10, 2017, the Chicago Board Options Exchange (CBOE), one of the leading derivatives exchanges in the US officially launched the trading of bitcoin futures contracts. A week later, on December 17, the Chicago Mercantile Exchange followed suit and also launched bitcoin futures on its exchange after the U.S. Commodity Futures Trading Commission (CFTC) approved the new financial product.

The announcement of bitcoin futures coming to two leading U.S. derivative exchanges sparked bitcoin’s incredible year-end rally that saw the price of bitcoin hit its 2017 high of USD 20,000 in mid-December, driven by the potential new investor funds that can now flow into bitcoin as both institutional investors and private investors are now able to bet on the price of bitcoin through a regulated investment vehicle.

What are Bitcoin Futures Contracts?

Futures contracts, also referred to as futures, are standardized exchange-traded financial derivatives that provide an agreement between a buyer and a seller to buy or sell an asset at a predetermined price on a predefined date.
Each futures contract represents a specific amount of the underlying asset and futures can be either cash settled or come with physical delivery. In the case of bitcoin futures, the underlying asset is the digital currency bitcoin.

How Do You Trade Bitcoin Futures?

To trade bitcoin futures on the CME or the CBOE as a private investor, you need an account with a brokerage that offers bitcoin futures trading. As for January of 2018, Interactive Brokers, TD Ameritrade, and Ally Financial offer this to their clients but more brokerages are expected to follow suit.

Once you are registered with a broker that allows you to trade bitcoin futures you can buy them online in the same fashion that you would buy futures on commodities like gold, silver or oil.

If you believe that the price of bitcoin will hit USD 20,000 by mid-February, you could purchase a CBOE Feb 17 XBT futures contract at USD 15,000. If by February 14, 2018, when the contract expires, the price is at USD 20,000, you will have made a profit of USD 5,000. This profit could be higher depending on the leverage that your broker can provide you with. Of course, you can also close out your trade ahead of the expiry date if you want to take profit earlier.

However, if during the time of the contract the value drops, your broker will ask you to top up your margin account to ensure you can cover potential losses from the trade. If you fail to top up your maintenance margin account when you receive a margin call, your trade will be closed out for you by your broker.

Due to the added leverage that futures bring, they are considered a much riskier investment than stocks and bonds.

However, futures can also be used to hedge investment risk by entering into a short position. This was actually the original idea of commodity futures when they were introduced for farmers to hedge their market risk. For example, if a farmer knows he will raise 10,000 bushels of corn, he can short sell one futures contract for corn (assuming one contract covers 10,000 bushels of corn) at a specific price with the expiry set to the time when he plans on selling his corn. If the price of corn should drop before the farmer can sell his corn, this loss is offset by the gains on the short futures contract. In effect, commodity futures allow producers to lock in the price at which they want to sell their product.

CME vs CBOE Bitcoin Futures

Futures are standardized exchange-traded financial products. However, futures contract do differ from exchange to exchange. That means you can only trade CME bitcoin futures on the Chicago Mercantile Exchange and CBOE bitcoin futures only on the CBOE.

While the two bitcoin futures contracts trade in the same way from a technical point of view, they have the following key differences:

CME bitcoin futures have the ticker ‘BTC’, have a contract unit of five bitcoins and 35% initial margin is needed to place a trade. CBOE bitcoin futures, on the other hand, have the ticker ‘XBT’, their contract unit is one bitcoin, and the margin requirement is 44%.

Both futures contracts are in US dollar and are cash settled, which means no bitcoin are exchanged at the end of the contract - only the cash difference. Also, both contracts have the three closest months listed as contract expiry dates.

If you are entirely new to futures trading, you can start out practicing using the CME’s bitcoin futures trading simulator before you place your first trade with your broker.

Bitcoin Futures - The Early Days

When bitcoin futures started to trade on the CBOE on December 10, 2017, the price rallied as investors were confident that the opening up of bitcoin to institutional investors in this format would bring new money into the asset class. On the exchange itself, however, trading volumes of bitcoin futures remained comparatively low and was reportedly largely dominated by retail investors[/URL] as institutional market participants were concerned about the clearing of these new futures.

Less than USD 10 million worth of bitcoin futures were traded on the CBOE in the first hour of trading while at the same time, the popular bitcoin exchange Bitfinex traded around USD 170 million worth of bitcoin.

Bitcoin futures trading volumes have remained comparatively low at both the CME and the CBOE. At both exchanges, the January expiry contract is the most popular and is experiencing the most trading volume while February and March contracts are seeing very little trading action.

Judging by the current rate, it looks like it will take a few more months before bitcoin futures will take up a larger share of trading at the CME and CBOE. This is most likely the case as the majority of large investment houses are still assessing the risks of gaining exposure to a decentralized digital currency such as bitcoin.

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