Is Twitter’s Favorite “Risk-Free” Bitcoin Trade Too Good To Be True?

Is Twitter’s Favorite “Risk-Free” Bitcoin Trade Too Good To Be True?
Stéphane Renevier, CFA

almost 3 years ago4 mins

Twitter’s been ablaze with an easy-to-execute trade that promises a risk-free annual return of over 15% – and yes, there is a catch. But there’s also something to it.

📈 What’s the trade?

It’s the “cash-and-carry” trade, which promises a guaranteed profit regardless of whether the underlying asset’s price – in this case, bitcoin’s – goes up or down.

Put simply, if the price of a futures contract is higher than the price of the underlying asset (known as “contango”), investors can buy the “cheap” asset and sell the “expensive” futures contract, pocketing the difference between the two.

Source: Twitter
Source: Twitter

🔧 How does the trade work in practice?

Bitcoin’s currently trading at around $56,300, while a September CME futures contract is selling for $59,180.

Source: barchart.com
Source: barchart.com

Please note: I’ve incorrectly used a contract size of 0.01 instead of 0.1 in the calculations below. This does not materially change the key numbers or the conclusion.

So in the cash-and-carry trade, you’d buy the futures contract, which gives you the right to buy or sell 0.1 bitcoin (the contract size of the micro contract) for $591.80 (0.1 x $59,180) when it expires in September. Meanwhile, you’d also buy 0.1 bitcoin for $563 (0.1 x $56,300).

Let’s say the price of bitcoin fell to $50,000 in September. Your 0.1 bitcoin would be worth $63 less, but your futures contract would allow you to sell your 0.1 bitcoin for the pre-agreed price, meaning you make $91.80 from it. That’d give you a profit of $28.80.

Now let’s say the price of bitcoin hit $60,000 in September. You’d make $37 from your bitcoin holding, but lose $10 on your futures contract (remember, 0.1 bitcoin is worth $600, but you already agreed to sell it for $591.80). Your profit is still $28.80 – exactly the same.

So as long as your transaction costs stay below $28.80, it is possible to generate a virtually risk-free return.

Source: Finimize
Source: Finimize

🤔 Is the 15% return too good to be true?

If you want to keep the trade low risk, then I’m afraid so.

Take our example, assuming a $5 transaction cost: your return on invested capital (ROIC) – which is calculated as net profit (after transaction fees) ÷ cash invested – would only be $23.80, or 2.06%. That’s 6.3% annualized – much lower than the promised 15%.

And to keep it as close as possible to risk free, you’d need to commit the capital to both buy 0.1 bitcoin ($563) and to collateralize your futures contract ($591.80). In other words, you’d need to stump up $1,154.80 to guarantee yourself the pretty measly profit of $23.80 after transaction fees. And when you could just use that money to buy bitcoin outright, the opportunity suddenly seems less attractive.

🎉 But could you make a 15%+ return?

Sure, there are two ways to generate those sorts of returns from the cash-and-carry trade. You just need to be aware that they’re not risk free.

You could short futures contracts that are trading on “riskier” exchanges, like BitMEX, Deribit, Kraken, or FTX. Futures on those exchanges are likely to trade at more attractive levels and have more lenient collateral and margin requirements, allowing you to reduce the amount of cash (or crypto) you need to invest and boost your ROIC. This does, however, come at the cost of higher risk, since the chances of bugs, fraud, hidden fees, and even exchange insolvency are much higher on one of these exchanges than on the CME.

You could use leverage to reduce the amount of capital required as collateral. That won’t just reduce exchange risk (since you have less cash or bitcoin held on the exchange), it’ll also boost your ROIC. On the other hand, you’ll now be facing margin and liquidation risks. Margin risk means you’ll need to add cash to your account if prices rise. Liquidation risk means the exchange could liquidate your whole position before you even have the chance to add cash to your margin, which could happen in the case of a sharp move up in price.

All things considered, mind you, the trade is providing attractive-looking returns for the given level of risk – especially if you have enough capital to go around. So while you should always take the Twitter gurus with a pinch of salt, this could be a sweet deal for the less risk-averse of you out there.

🥡 Key takeaways

  • A cash-and-carry strategy lets you lock in the difference between futures prices and the underlying asset, without any exposure to rising or falling prices.
  • And it is possible to use the strategy to produce risk-free returns: they’re just nowhere near as high as some claim.
  • It’s also possible to earn the 15%+ return the Twitter gurus are promising, but not without taking on exchange, margin, or liquidation risks.
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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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