I have securities that have crypto-currencies (say, XBT/BTC) as a base currency and I want to avoid the tremendous volatility of this market. There are options for margin trading of sorts (shorts, longs, futures) but I can't find a good explanation on how could I use them to hedge.

I understand it is possible, as everyone relates to futures as a way to hedge (and I figured out that shorts with leverage could also give me the same results), but I could not find a source explaining how to do it, how it does work, and which of the various methods (if indeed there is more than one) is best.

  • @RodrigodeAzevedo I see that they have futures (many do) the question is how to use those futures (or inverse ones such as Bitmex's) to hedge in the best way. – borgr Jul 8 '18 at 10:35

The sort of "hedging" you have heard about on business TV simply doesn't apply to such bizarre/thin/unusual markets; and it only applies when large wholesale amounts of the item in question is in play. the concept is totally irrelevant to your situation.

To "eliminate the risk", trivially sell to Dollars or Euros. One click.

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  • That dos not answer the questions, the base assumption here is that I have holds in BTC equivalent (for simplicity say I just have a bitcoin I can not sell), the question is how can I use futures to hedge the risk. For example I figured shorts would rise when my Bitcoin will fall. – borgr Jul 8 '18 at 10:34
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    futures in what? The only useful ones here would be futures in your crypto currency - are there any? – mmmmmm Jul 8 '18 at 11:33
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    @borgr This answer is 100% correct. Don't pretend that this type of gambling is one where standard investing logic applies - it doesn't. If you want to avoid the volatility of speculation (which you should want), then don't speculate. – Grade 'Eh' Bacon Jul 8 '18 at 13:07
  • "the question is how can I use futures to hedge the risk". You can not. Exactly as it explains why in detail in this answer. – Fattie Jul 8 '18 at 14:29
  • @Fattie I would like to understand why, I strongly disagree about in detail, the answer as claims but no evidence supporting them. And just as a counter example why it is possible (I am looking to understand about other ways), suppose I have a bitcoin and buy with a bitcoin worth of shorts with X2 leverage won't I get the hedging I needed? – borgr Jul 8 '18 at 14:47

The basic concept of hedging is that you pay a modest amount now to avoid a catastrophic result later. So the question is what a catastrophic result might be in this case. You have bitcoin or a promise of bitcoin in the future. You want some other currency or goods. It would be catastrophic for the value of bitcoin to fall.

A bitcoin/goods hedge may be hard to find, because I'm not sure that the goods market in bitcoin is well enough developed to have real futures. In theory though, you could buy an option allowing you to buy some good for a particular amount of bitcoin. If the value of bitcoin goes down, you exercise your option (or sell the option and use the proceeds to buy normally). If the value goes up, you let the option expire and buy normally.

You already know about currency futures. You want to hedge against a fall in bitcoin prices. You buy a put option where you put your bitcoin in exchange for some other currency (e.g. US dollars or whatever works best for you). With the put option, you are guaranteed a certain price for your bitcoin. If bitcoin falls you exercise the option (or sell the now profitable option to someone else and use the proceeds). If bitcoin rises, you let the option expire and sell your bitcoin normally.

This would be a put option in terms of the other currency. From the bitcoin perspective, it could be considered a call option. The important part is that it guarantees to you that if you exercise the option that you will get a certain amount of the other currency for your bitcoin. You may have to read the option carefully so that you get the right option with that property. Don't get too caught up in the name, which depends on perspective. It's the property that is important.

You may wonder if call options are valuable. As a hedge, no. But if you need a certain amount of the other currency (not bitcoin), you might be willing to sell a call option. You can then use the proceeds from that sale to purchase your put option. This surrenders your potential profits, but the purchase of the put avoids potential losses.

As others have noted, it would make more sense to sell the bitcoin now than to go through this hedging process. This only makes sense if you can't sell now (e.g. you haven't been paid yet). You should realize though that if you are promised bitcoin, you also have the risk that you won't get the promised bitcoin. If you sell a call option in that case, you could find yourself forced to buy bitcoin to service the option.

Buying the put is less dangerous. At worst, you don't get the bitcoin and can't exercise the option. You have to let the option expire. Even in that case though, you might sell the option and make money that way. Buying an option is inherently safer in terms of exposure, as you choose whether to exercise. You can always choose no.

Selling is more dangerous as the other side can choose whether to exercise and will tend to do so when it is disadvantageous to you. If the option is covered because you already have the thing that you purchase, that's what makes it safe. But make sure that you really do have it, not just the promise of it. Or accept the risk that comes with not getting it.

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  • "I'm not sure that the goods market in bitcoin is well enough developed to have real futures." The CME disagrees, as does the CBOE, which both have Bitcoin futures in their futures lineup. – TomTom Jul 8 '18 at 11:37
  • My guess is that the OP is looking for a very specific answer (as in, "clicking on site P and button Q, you can click A to buy B of C for each D units of blah blah") - that being said, you can read my answer :) – Fattie Jul 8 '18 at 18:01

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