CME, the Wall Street giant that mainly serves banks, has announced they are to launch bitcoin options this January, with such options based on the cash settled bitcoin futures.
That will allow bankers to turbo charge their gambling on margin with it unclear whether CME also plans to offer derivatives swaps that run on the options which run on the futures which run on the spot price of actual bitcoin exchanges like Coinbase.
Options as you may know are a fairly simple concept. Instead of buying a house outright, you secure the right to buy it say within a year by putting down 5% of the price.
Meaning you can run on 100x margin or more because with say just 5%, you are sort of the owner of the gains or losses on $95,000.
If the price goes down to $80,000, you just don’t buy the house, meaning you lost $5,000. If it goes up to say $200,000, well now you’ve made $100,000 from just $5,000.
Crazy huh? Except there’s no house – or bitcoin – at CME. You’re not exercising an option to buy them, because CME never touches bitcoin. So you never receive bitcoin which you then have to sell to unlock this $100,000, you instead receive the $100,000 straight away.
That’s from the buyer’s side. There’s obviously gotta be someone that gives you this option, that is happy to let you have a bitcoin-right for say just $500.
That someone makes money if the bitcoin price falls, but only if they don’t have any actual bitcoin. If bitcoin’s price doubles, they’d lose $10,000, which is a lot.
You’d think therefore they’d have to buy actual bitcoin to cover themselves if the price rises. But they can also just buy fake futures, but in that case they’d lose if the price falls too.
The question is obviously why would they offer this option for just $500 if they would lose whether price goes up or down?
So let’s make it concrete. A has one bitcoin, physical or fake futures irrelevant, price is $10,000. Drops to $8,000, lost $2,000. Gained $500 from B, so lost $1,500. Rises $12,000. Owes $2,000 to B who pays him $500. Lost $1,500.
In other words, A always loses and never gains. So why on earth would they offer this option?
With a house, well presumably B actually wants to buy it, but is not sure. A wants to sell it, so presuming there is no outright buyer, they agree to the option.
With actual bitcoin too, again presumably they want to buy it, but maybe they expecting the money to come in soon and don’t have it yet, etc. Again, the seller actually wants to sell it, but presumingly they couldn’t find an outright buyer.
In the case of CME, you’d want to offer such option because you charge a premium. It’s not clear what their premium is in their specs , but it might be as high as 20%, on top of the 5%, because bitcoin is very volatile.
So now you’d get $2,500 if it falls 20%, and you’d get $2,500 if it rises, making a $500 gain either way. B thus would have to bet price moves more than your premium in his direction.
It could make sense if there is actual delivery, but here as nothing is actually exchanging hands, it’s all basically just derivatives upon derivatives that do not engage in any real economic activity nor perform any real economic function.