If there was one asset class that took the full force and fury of sellers last year, it was crypto, including blockchain and anything related to decentralized finance. One of the often quoted lines from William Shakespeare's Macbeth is Lady Macbeth claiming, "What's done is done and cannot be undone."
So far in 2023, Crypto investors have taken that line to heart and moved on from last year with a vengeance as you can see in the below table. But I have a strategy for the sector that I'll show you further down.
Source: Factset, All You Can ETF
While the year-to-date returns through Tuesday for some of these funds are impressive, let's not forget some basic math, like that seeing as Bitwise Crypto Industry Innovators ETF (BITQ) and Global X Blockchain ETF (BKCH) each declined roughly 80% last year they would need to rise 500% just to break even. Still, the run on bitcoin and Etherium's ether is a welcome relief for both "HODLRs" and traders alike.
What is Happening?
For those readers who follow the space closely, you may have seen coverage of a Bernstein research note published Monday, which has called the year-to-date rally in bitcoin a case of mean reversion as bitcoin ended the year in a massively oversold position due to some fairly substantial legal overhang from not just from the FTX crypto exchange saga, but also the Digital Currency Group, which owns Grayscale, Genesis and CoinDesk. Analysts Gautam Chhugani and Manas Agrawal maintain that while the rally is normalizing bitcoin price levels, they do not see "capital allocations to sustain this rally."
So, what does this mean for bitcoin prices? If we are taking 2022 as an observation period, the mean price in 2022 was just under $28,300. If we extend that observation period to include 2018 through 2022, that average price is reduced to just over $20,000. Given that BTC is currently pricing at roughly $23,000 and that these levels have brought the combined value of all available coins back to $1 trillion It's not clear to me what other catalyst is going to push bitcoin higher from here.
This type of situation might be best suited for an options-based approach. With this level of uncertainty, I'd be tempted to establish a long straddle on the ProShares Bitcoin Strategy ETF (BITO) . If you're wondering, a straddle is kind of like the option trader equivalent of betting on black and red at the roulette table, except that you have better odds of coming out ahead with a straddle, assuming of course the underlying moves enough to clear the cost of your position. Let me explain.
A Straddle is established by buying both a call and a put contract with a strike price as close to the then current price of the underlying you are using. BITO closed at $14.55 on Jan. 25. The closest at-the-money (ATM) contract is the 14.50 strike contract. Because I want to give some time for a move to happen in BITO, so let's use Feb. 23 expiry contracts to establish this position. Let's use the closing prices for these contracts to establish the position. The Feb. 23, $14.5 strike BITO call closed at $0.97, and the same expiry and strike put closed at $0.95.
Standard-listed option contracts represent exposure to 100 shares of the underlying security, so while the prices of these contracts are $0.97 and $0.95, the cost of each would be $97 and $95, respectively. In other words, this straddle would not only cost $192 to set up, but the worst case scenario is that you could lose $192 in the event that BITO moves $1.92 or less in either direction from $14.50 (your contract strike price). In other words, in order for you to make money, BITO would have to close either above $16.42 or below $12.58. Any move less than this means you, in the words of Mr.Wonka, "get nothing!"
Let's model out some potential payoff scenarios. Let's say you feel that BITO's run up from $10.43 on Dec. 30, 2022 to the January $14.55 close is pure hype and you're seeing BITO heading back to that level sooner than later. Assuming that happens, your call expires worthless, so you lose $0.97 ($97 of premium paid). Your put has $4.07 of what is called intrinsic value (in this case, the strike price less the underlying spot price). Considering you paid $1.92 to establish the Straddle (cost of Call + Cost of Put), you made $2.15 on the trade, or $215 given the times-100 multiplier on the contract. At this point, I should tell you that unless you want to actually borrow shares of BITO at $10.43 and deliver them to whoever sold you the contract and receive $14.50 per share, you should just sell the contract before it expires (mark it "Sell to Close" with your broker).
Let's now say that you were wrong before and BTC continues to run to the $28,300 2022 average price calculated earlier, taking BITO with it back to the $17.56 average, BITO price in 2022. The math is the same here. Your Put expires worthless and your Call has $3.06 of intrinsic value. When you back out the cost of establishing the position, you are left with $3.06 - $1.92, or $1.14 ($142 given the multiplier). In this case, unless you want to take possession of 100 shares of BITO at $14.50 (for a cost of $1,450) you should sell the call before it expires.
Wrap It Up
I know my columns usually focus on ETFs, and not options trading strategies, but the situation with BTC right now is tougher than usual. This asset class displays no fundamentals and seems to trade purely on headlines, lawsuits, and what could generously be described as "Dark Pool" trading. To me, Crypto is a prime candidate for technical analysis coupled with an intuitive (and strong) gut. To be clear, this example is not meant to be trading advice, just an example of how options could help you navigate uncertainty.