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I am trying to understand risks with arbitrage for professional traders with BTC spot (at Coinbase gdax) and CBOE Futures contract. Let us say, some profession

I am trying to understand risks with arbitrage for professional traders with BTC spot (at Coinbase gdax) and CBOE Futures contract. Let us say, some professional trader "Short sell CBOE Future contract & Buy BTC Spot at Coinbase simultaneously" At the time of this writing, Futures contract short sell @ $18700 and BTC Spot buy @ $16700 simultaneously. http://cfe.cboe.com/cfe-products/xbt-cboe-bitcoin-futures http://cfe.cboe.com/cfe-products/xbt-cboe-bitcoin-futures you wait one month for the Futures contract to expire (Jan 17 th) , let us examine two scenarios by contract expiry Jan 17 th . case 1: Bitcoin price shoots to $25,000 case 2: Bitcoin price drops to $8,000 In both cases on the futures contract expiry date that is January 17 th 2018, bitcoin Futures price and Spot price will be almost same ( give or take $100) In both cases professional traders profit is $2000 for each futures contract on the investment of $16,700 Spot + $10,000 future initial price. That is $2000 profit on $26,700 investment for one month period , that works as 7% return per month, annualized 84% . You may need to deduct cost of money that is interest on investment or loan say 6% per year . One risk I see is, on the Short sell Futures contract, if the bitcoin is keep rising in price , trader needs to supply more money to meet the margin call ( just a technial issue because he is gaining on the LONG Buy bitcoin spot price ) Am I missing some thing ??

isolli 9y ago
Liquidity I assume. It may be difficult to sell $25,000 worth of Bitcoin at the settlement price on the settlement date. Slippage could be more than the $2,000 profit you estimated. Especially if many people do the same trade.
andruby 9y ago
(I am not a professional investor) Why is there a gap of 11% between the CBOE Future contract price and the BTC Spot price? Should they not be closer in a perfect market? Maybe the gap will be the same on the contract expiry date? Is this because the arbitragers still need to integrate the CBOE Futures into their system? Even between bitcoin exchanges, the bitcoin price varies. $17240 on cex and $16310 on bitstamp.
- LrnByTeach 9y ago
  Futures contract has TIME value, so they are usually higher than the SPOT price, please check this link for detailed explanation . https://www.investopedia.com/terms/f/futurescontract.asp https://www.investopedia.com/terms/f/futurescontract.asp Thought it is not exactly same, but similar case is Where you pay Premium with Stock Options to have the right RIGHT to buy the stock one month from now. Regarding cex & bitstamp they are exchange out side of USA, each of them have different Risk factors associated to each of those exchanges, that is why that price difference . Coinbase and CBOE are both US based exchanges and are under govt. regulation and are reputable than any other bitcoin exchanges in the world.
  - andruby 9y ago
    Is 11% not a huge time value premium for something that expires in a month? Can we compare the time premium with the interest rate? I have traded options, but never futures. With options there several components that increase the premium besides just the time component. According to [0] futures shouldn't have a time premium because both parties are obligated to to fulfill the contract. As you stated in the OP, the 11% spread should be a "riskless" arbitrage. If so, I suspect that this spread will decrease. [0] https://money.stackexchange.com/questions/12359/do-futures-have-premium-in-the-price-just-as-options-do https://money.stackexchange.com/questions/12359/do-futures-h...
    - richardw 9y ago
      > Is 11% not a huge time value premium for something that expires in a month? Not for Bitcoin. You can hit that in a day. I'd be happy to bet we move 11% in one direction or another within 30 days
    - soVeryTired 9y ago
      Yes, -11% carry in a month is absolutely bonkers.
    - omellet 9y ago
      It is a huge premium. In reality it should only be the future value of the current spot, given the current interest rate. For other types of futures (oil, grains) that have storage costs or seasonality there are other factors that affect the difference between the spot and future price, but for financial futures (especially cash-settled) it should be nearly no difference for a one-month expiry.
lug0r 9y ago
> if the bitcoin is keep rising in price , trader needs to supply more money to meet the margin call This can get quite expensive.
- LrnByTeach 9y ago
  additional $10,000 margin call is well with in the profit margin (on the money interest rate basis), unless bitcoin goes to $100,000 by next month.
omgtehlion 9y ago
When you buy base and simultaneously sell future contract, you effectively lend your money to other counterparty. In ideal market this should be equal to interest on loan (as you mentioned). There are two possibilities of what is really going on: - either there are not enough arbitragers yet - or you should factor in commissions, fees, ease of transferring money between exchanges, etc
- runeks 9y ago
  > When you buy base and simultaneously sell future contract, you effectively lend your money to other counterparty. In ideal market this should be equal to interest on loan (as you mentioned). Good point. But the interest on what amount, exactly? You need both 1) capital to buy bitcoins and 2) capital used for margin on the futures exchange. The latter amount is unpredictable, and if the bitcoin price shoots to 10x the spot purchase price you will need to borrow ~35% of this amount for margin, thus making the effective interest around 4x the market rate. So, in short, the amount that the futures contract price will deviate from spot should be proportional to the volatility of the bitcoin price (because you need to borrow an amount proportional to this for use as margin). But this only applies to cash-settled bitcoin futures contracts. If settled in bitcoins, it should be sufficient to deposit bitcoins at the futures exchange as margin — thus making the price of these, physically settled, futures contracts only depend on the prevailing short-term rate of interest, as far as I can see.
user5994461 9y ago
>>> case 1: Bitcoin price shoots to $25,000 >>> case 2: Bitcoin price drops to $8,000 case 3: one of the exchanges canceled your order shortly after they were done. case 4: the exchange refuses to pay you out for whatever reason they invent. case 5: the exchange goes bust, either seized by the police, hackers or the owner outright left with all the money. In all these cases. You are likely to loose 100% of the sum you invested.
- nawtacawp 9y ago
  Just want to add for those new to btc, these are not far fetched scenarios — they have all happened in the past.
  - Qub3d 9y ago
    I personally just lost $200 on NiceHash; not a big sum, but enough to give me a scare. Its frustrating, because I've had concerns about this happening before, but its so difficult to find a good service outside Coinbase.
    - nawtacawp 9y ago
      SFYL
  - knowThySelfx 9y ago
    Does this remind us of some glorified Ponzi scheme? How does Bitcoin get hacked? It certainly isn't easy unless you are an insider. And perhaps NSA, since they created SHA-256. https://bitcointalk.org/index.php?topic=291217.0 https://bitcointalk.org/index.php?topic=291217.0 The bubble will burst - some people will make money out of this and a whole lot of others will lose.
    - deleted 9y ago
      [deleted]
    - nawtacawp 9y ago
      I believe the hacks OP was referencing doesn’t have to do with SHA, but more to do with bitcoin exchange security and not protecting their btc correctly.
d--b 9y ago
As others pointed out, when you buy/sell futures, you risk counterparty risk. But it's not that bad because that exchange is really good and people entering the market pay margin calls every day. There is also a financing cost (ie. the cash you use to pay for your margins, transaction costs, and to buy the bitcoins will not pay you any interests over the time of the position). But again, the effect is not very large. What really makes arbitraging bitcoin futures difficult is the illiquidity of bitcoins. "Simultaneously" is a hard thing to do in bit coin world where transaction are slow to process and price is very volatile. And you not only need to do this when you buy into the position, but also when you want to end it. At the end of the contract, you're left with a bunch of bitcoins, and some cash (or not). Now you need to liquidate all those remaining bitcoins. This could take some time, and the price you get in the end could be quite different from the price the future settled into. That said, the difference between future and spot is likely to become closer as the market professionalizes and more arbitragers get in.
- mathgenius 9y ago
  The bitcoin exchanges have plenty of liquidity, and executions happen in less than one second. The real risk for arbitrage is with the crypto exchange itself: these can go bust, or disappear overnight. You wanna keep $1M sitting on one of these exchanges?
  - d--b 9y ago
    Mmmh, why do you need your coins sitting on one exchange? Can't you just take them out once your transaction is done?
    - jacobush 9y ago
      And that is precisely when the trickle begins... nothing ”at once” about taking them out.
    - mathgenius 9y ago
      Sure, but you still need to put funds into the exchange to buy the coin in the first place. And likely you would leave the coins there in case the trade goes the otherway. Managing that many coins in your own wallet is a whole other headache. But I guess your point is to not leave much on the exchange at any one time.
bitxbit 9y ago
Has a lot to do with trader preference. Stable exchange platform, 1256 contract tax treatment, the list goes on and on. A large scale arbitrage may not be feasible. In addition, market makers on the futures market are likely working off of a sizable inventory/pool of BTC. And they are likely pricing in a fat premium on top of anticipated buy orders. So they’re effectively acting as arbitrageurs. Bid-ask spread plus futures premium. 10-12% is rich but understandable.
ringaroundthetx 9y ago
Tax treatment of futures is AMAZING The margin is free and its much greater (usually) than what you get in other markets
- wdn 9y ago
  Margin is a two edged sword. Beside, margin in futures mean different think than margin on stock. Yes, futures tax treatment is great. Index options also get the same tax treatment
tcoppi 9y ago
CBOE settles to Gemini's spot price, not GDAX. The prices between exchanges differ dramatically currently.
- where_do_i_live 9y ago
  You are correct it trades to Gemini's spot price, but you are wrong in terms of the difference between the two. As I write this there is a 5 cent different between GDAX and Gemini.
  - scrumbledober 9y ago
    in general they are very close but at times of extreme volatility they can differ quite a bit, as was the case several days ago when GDAX surged up past $19,000/BTC and then crashed.
traderThrowAway 9y ago
If someone wanted to borrow US$1m from you, and gave you Bitcoin as collateral, what interest rate would you require?
- thinkmassive 9y ago
  Crypto-collateralized loans are being launched by a startup called Salt Lending. I’m expecting rates to start around 10%, although I’m unsure where I heard that. https://www.saltlending.com/ https://www.saltlending.com/
bluesign 9y ago
sorry I have no idea about futures but where the $10000 figure coming from?
anticipation 9y ago
You are forgetting the fact that bitcoin can also go to zero during which there's counter party risk.
Tepix 9y ago
What happens if the price remains near the current price?
- LrnByTeach 9y ago
  Same thing, the trader profit in this CASE mentioned is still same $2000
Veratyr 9y ago
What you're missing is that these prices will converge as the Futures market develops and more professional arbitragers get on board. When that happens the gap will shrink significantly and be far less profitable.

isolli 9y ago

Liquidity I assume. It may be difficult to sell $25,000 worth of Bitcoin at the settlement price on the settlement date. Slippage could be more than the $2,000 profit you estimated. Especially if many people do the same trade.

andruby 9y ago

(I am not a professional investor) Why is there a gap of 11% between the CBOE Future contract price and the BTC Spot price? Should they not be closer in a perfect market? Maybe the gap will be the same on the contract expiry date? Is this because the arbitragers still need to integrate the CBOE Futures into their system? Even between bitcoin exchanges, the bitcoin price varies. $17240 on cex and $16310 on bitstamp.

LrnByTeach 9y ago
Futures contract has TIME value, so they are usually higher than the SPOT price, please check this link for detailed explanation . https://www.investopedia.com/terms/f/futurescontract.asp https://www.investopedia.com/terms/f/futurescontract.asp Thought it is not exactly same, but similar case is Where you pay Premium with Stock Options to have the right RIGHT to buy the stock one month from now. Regarding cex & bitstamp they are exchange out side of USA, each of them have different Risk factors associated to each of those exchanges, that is why that price difference . Coinbase and CBOE are both US based exchanges and are under govt. regulation and are reputable than any other bitcoin exchanges in the world.
- andruby 9y ago
  Is 11% not a huge time value premium for something that expires in a month? Can we compare the time premium with the interest rate? I have traded options, but never futures. With options there several components that increase the premium besides just the time component. According to [0] futures shouldn't have a time premium because both parties are obligated to to fulfill the contract. As you stated in the OP, the 11% spread should be a "riskless" arbitrage. If so, I suspect that this spread will decrease. [0] https://money.stackexchange.com/questions/12359/do-futures-have-premium-in-the-price-just-as-options-do https://money.stackexchange.com/questions/12359/do-futures-h...
  - richardw 9y ago
    > Is 11% not a huge time value premium for something that expires in a month? Not for Bitcoin. You can hit that in a day. I'd be happy to bet we move 11% in one direction or another within 30 days
  - soVeryTired 9y ago
    Yes, -11% carry in a month is absolutely bonkers.
  - omellet 9y ago
    It is a huge premium. In reality it should only be the future value of the current spot, given the current interest rate. For other types of futures (oil, grains) that have storage costs or seasonality there are other factors that affect the difference between the spot and future price, but for financial futures (especially cash-settled) it should be nearly no difference for a one-month expiry.

lug0r 9y ago

> if the bitcoin is keep rising in price , trader needs to supply more money to meet the margin call This can get quite expensive.

LrnByTeach 9y ago
additional $10,000 margin call is well with in the profit margin (on the money interest rate basis), unless bitcoin goes to $100,000 by next month.

omgtehlion 9y ago

When you buy base and simultaneously sell future contract, you effectively lend your money to other counterparty. In ideal market this should be equal to interest on loan (as you mentioned). There are two possibilities of what is really going on: - either there are not enough arbitragers yet - or you should factor in commissions, fees, ease of transferring money between exchanges, etc

runeks 9y ago
> When you buy base and simultaneously sell future contract, you effectively lend your money to other counterparty. In ideal market this should be equal to interest on loan (as you mentioned). Good point. But the interest on what amount, exactly? You need both 1) capital to buy bitcoins and 2) capital used for margin on the futures exchange. The latter amount is unpredictable, and if the bitcoin price shoots to 10x the spot purchase price you will need to borrow ~35% of this amount for margin, thus making the effective interest around 4x the market rate. So, in short, the amount that the futures contract price will deviate from spot should be proportional to the volatility of the bitcoin price (because you need to borrow an amount proportional to this for use as margin). But this only applies to cash-settled bitcoin futures contracts. If settled in bitcoins, it should be sufficient to deposit bitcoins at the futures exchange as margin — thus making the price of these, physically settled, futures contracts only depend on the prevailing short-term rate of interest, as far as I can see.

user5994461 9y ago

>>> case 1: Bitcoin price shoots to $25,000 >>> case 2: Bitcoin price drops to $8,000 case 3: one of the exchanges canceled your order shortly after they were done. case 4: the exchange refuses to pay you out for whatever reason they invent. case 5: the exchange goes bust, either seized by the police, hackers or the owner outright left with all the money. In all these cases. You are likely to loose 100% of the sum you invested.

nawtacawp 9y ago
Just want to add for those new to btc, these are not far fetched scenarios — they have all happened in the past.
- Qub3d 9y ago
  I personally just lost $200 on NiceHash; not a big sum, but enough to give me a scare. Its frustrating, because I've had concerns about this happening before, but its so difficult to find a good service outside Coinbase.
  - nawtacawp 9y ago
    SFYL
- knowThySelfx 9y ago
  Does this remind us of some glorified Ponzi scheme? How does Bitcoin get hacked? It certainly isn't easy unless you are an insider. And perhaps NSA, since they created SHA-256. https://bitcointalk.org/index.php?topic=291217.0 https://bitcointalk.org/index.php?topic=291217.0 The bubble will burst - some people will make money out of this and a whole lot of others will lose.
  - deleted 9y ago
    [deleted]
  - nawtacawp 9y ago
    I believe the hacks OP was referencing doesn’t have to do with SHA, but more to do with bitcoin exchange security and not protecting their btc correctly.

d--b 9y ago

As others pointed out, when you buy/sell futures, you risk counterparty risk. But it's not that bad because that exchange is really good and people entering the market pay margin calls every day. There is also a financing cost (ie. the cash you use to pay for your margins, transaction costs, and to buy the bitcoins will not pay you any interests over the time of the position). But again, the effect is not very large. What really makes arbitraging bitcoin futures difficult is the illiquidity of bitcoins. "Simultaneously" is a hard thing to do in bit coin world where transaction are slow to process and price is very volatile. And you not only need to do this when you buy into the position, but also when you want to end it. At the end of the contract, you're left with a bunch of bitcoins, and some cash (or not). Now you need to liquidate all those remaining bitcoins. This could take some time, and the price you get in the end could be quite different from the price the future settled into. That said, the difference between future and spot is likely to become closer as the market professionalizes and more arbitragers get in.

mathgenius 9y ago
The bitcoin exchanges have plenty of liquidity, and executions happen in less than one second. The real risk for arbitrage is with the crypto exchange itself: these can go bust, or disappear overnight. You wanna keep $1M sitting on one of these exchanges?
- d--b 9y ago
  Mmmh, why do you need your coins sitting on one exchange? Can't you just take them out once your transaction is done?
  - jacobush 9y ago
    And that is precisely when the trickle begins... nothing ”at once” about taking them out.
  - mathgenius 9y ago
    Sure, but you still need to put funds into the exchange to buy the coin in the first place. And likely you would leave the coins there in case the trade goes the otherway. Managing that many coins in your own wallet is a whole other headache. But I guess your point is to not leave much on the exchange at any one time.

bitxbit 9y ago

Has a lot to do with trader preference. Stable exchange platform, 1256 contract tax treatment, the list goes on and on. A large scale arbitrage may not be feasible. In addition, market makers on the futures market are likely working off of a sizable inventory/pool of BTC. And they are likely pricing in a fat premium on top of anticipated buy orders. So they’re effectively acting as arbitrageurs. Bid-ask spread plus futures premium. 10-12% is rich but understandable.

ringaroundthetx 9y ago

Tax treatment of futures is AMAZING The margin is free and its much greater (usually) than what you get in other markets

wdn 9y ago
Margin is a two edged sword. Beside, margin in futures mean different think than margin on stock. Yes, futures tax treatment is great. Index options also get the same tax treatment

tcoppi 9y ago

CBOE settles to Gemini's spot price, not GDAX. The prices between exchanges differ dramatically currently.

where_do_i_live 9y ago
You are correct it trades to Gemini's spot price, but you are wrong in terms of the difference between the two. As I write this there is a 5 cent different between GDAX and Gemini.
- scrumbledober 9y ago
  in general they are very close but at times of extreme volatility they can differ quite a bit, as was the case several days ago when GDAX surged up past $19,000/BTC and then crashed.

traderThrowAway 9y ago

If someone wanted to borrow US$1m from you, and gave you Bitcoin as collateral, what interest rate would you require?

thinkmassive 9y ago
Crypto-collateralized loans are being launched by a startup called Salt Lending. I’m expecting rates to start around 10%, although I’m unsure where I heard that. https://www.saltlending.com/ https://www.saltlending.com/

bluesign 9y ago

sorry I have no idea about futures but where the $10000 figure coming from?

anticipation 9y ago

You are forgetting the fact that bitcoin can also go to zero during which there's counter party risk.

Tepix 9y ago

What happens if the price remains near the current price?

LrnByTeach 9y ago
Same thing, the trader profit in this CASE mentioned is still same $2000

Veratyr 9y ago

What you're missing is that these prices will converge as the Futures market develops and more professional arbitragers get on board. When that happens the gap will shrink significantly and be far less profitable.