Anyone who owned Bitcoin for long enough to have experienced its wild appreciation was excited to learn in December that the Chicago Board of Options Exchange (CBOE) was authorized to permit trading in Bitcoin futures (CBOE,XBT). Somehow I knew this would not be what I expected and the game would be rigged in favor of insiders. I guessed this for four big reasons:
- Most of Bitcoin owners are retail investors.
- Retail investors were basically prohibited from shorting the XBT.
- The CBOE was designing a “cash settled” product.
- Institutional owners like Winklevoss twins saw a one time chance to lock in gains without selling much Bitcoin
I was not disappointed in the final rules and I was not surprised by the result. Up to and including the first 3 days after the CBOE began futures trading the price of Bitcoin futures, XBT, spiked. The price of Bitcoin actually bounced off $20,000 in intraday trading. Any speculator who was long Bitcoin knew enough to try to hedge his gains by shorting Bitcoin on the futures exchange.
Retail Investors Can’t Sell Short
It would be just like shorting General Electric (GE,NYSE) when you owned the underlying stock! If the stock went down, you made money on your short position but if the stock went up, you lost on your short bet but made money on the appreciation in GE. Unfortunately, in early trading there was only one securities firm in America who would allow its customers to short XBT on the CBOE. That firm required a cash margin of 45-50% in addition to the proceeds. Because the terms of trading required settlements in cash (not Bitcoin) this meant the retail investor had to deposit cash. I called the CBOE and talked to a trader on the futures desk. He said that only institutional customers were permitted to short Bitcoin but retail investors were welcome to buy a futures contract betting that the price of Bitcoin would rise. In a recent article in the January 8, 2018 edition The WSJ implies that the smart money (institutional) is short and the dumb money (retail) is long. What they don’t says is how nearly impossible it is for a retail investor to short XBT. The chart below suggests the little guy is choosing the long position when, in fact, it is the only side he can buy.
When I saw this chart I immediately thought of spawning salmon all stacked up trying to get back to their spawning ground and a grizzly bear catching them in mid leap.
The Winklevoss Twins Controlled The Market
The salmon were retail investors in a frenzied state of wanting to get rich quick and jumping out of their shoes as their Bitcoin bet made higher and higher levels. I then thought of the Winklevoss twins as the grizzly bear who was allowed to go short but who also owned half a billion dollars of Bitcoin and had enough clout to actually condition the market frenzy. The little guy was only allowed to go one direction but the institutional investor could be on both sides of the trade.
When the little guy saw his Bitcoin at $20,000 per Bitcoin he wanted to lock in his good fortune. However, he was quickly disappointed to discover he could not hedge. Alternatively, many tried to sell. Meanwhile the Winklevoss twins probably shorted the XBT futures contract , but as experienced traders they also timed actual sales of Bitcoin for maximum market pressure on the downside. Then the stories about Bitcoin energy consumption and government regulation began to emerge.The price of Bitcoin cratered.
The salmon also discovered that settling in cash is different than settling in the underlying security that you already own. As the price of Bitcoin declined holders of the long position on XBT forfeited their option premium to the Grizzly and then desperately sold Bitcoin to try to compensate for their cash option premium loss on the derivative product. This assured a tax bill and their complete destruction on their futures bet.
CBOE wins big. Winklevoss twins win big and lock in gains on their holdings without selling much in the primary market. Grizzlies get the salmon. Round Two may be starting soon because there are still a lot of salmon backed up at the dam.
