Bearish Bitcoin ETF could let crypto skeptics short BTC — kinda
Exchange-Traded Fund (ETF) provider Direxion filed SEC paperwork for a Bitcoin Strategy Bear ETF earlier this week, a bid to allow investors to mimic the process of shorting Bitcoin.
The fund is intended to manage short exposure to BTC using Chicago Mercantile Exchange (CME) futures — the same reference pricing as ProShares’ Bitcoin ETF, BITO.
Direxion is famous for leveraged and derivatives-based ETFs like its flagship 2X and 3X leveraged ETFs.
It also offers strategic, thematic, and other fund types. The company manages $25 billion across its suite with an average expense ratio of 1.03%.
Shorting CME futures is not shorting Bitcoin
CME futures do not always reflect the price of Bitcoin because they’re contracts to buy or sell the underlying asset at an agreed-upon price at some point in the future.
Portfolio managers often hold futures as a hedge against the price of the underlying asset, because futures can often be traded for less than the price of the actual (“spot”) asset.
- If the price moves advantageously by the time the futures contract expires, owners can usually exercise their right to buy or sell the underlying asset. That means actually accepting delivery of the asset in-person, usually at a certified warehouse in Chicago.
- In the case of Bitcoin and other “cash-settled” futures, no physical delivery occurs.
- The contract holder may also choose to roll over their contract by extending the expiration date.
Roll overs typically require the holder to pay cash to close out the existing contract and open a new futures expiring on a later date.
These derivatives have super high margin requirements
To trade a futures contract, investors post a small percentage of the underlying asset, or initial margin, which is the amount that a trader needs in order to open a position.
Once the position is open, investors must post additional maintenance margin as the contract fluctuates in value.
Initial and maintenance margin apply to all futures contract owners — including Direxion as the fund’s manager. Typically, the initial margin is between 3% and 12%.
For the regular CME contract worth 5 BTC ($306,000), margins are extraordinarily high: 50%.
This means Direxion could receive a large (and expensive) margin call, even if Bitcoin moves up in price slightly.
So, Direxion must post 5X more margin for the Bitcoin contract, as opposed to normal maintenance of 10%,
Bitcoin bear ETF could decouple, like what happened to oil
In addition to cost drags like management fees and futures contract rolling costs (extending the ETF’s futures maturities as months progress), Direxion’s Bitcoin bear ETF could dislocate from Bitcoin’s price during substantial periods of price volatility.
Normally, the values of certain investment options like futures and their underlying assets will move together. When price-tracking breaks, the incident is known as decoupling.
Futures-based ETFs famously broke during the negative-price oil shock last year. The ETF that broke was USO.
Under normal market conditions, the futures price of real assets like oil never go negative, even in worst-case scenarios.
A negatively-priced futures contract means that the buyer will receive money to accept delivery of the asset upon expiration of the contract.
However, in April 2020, the price of the May 2020 West Texas Intermediate Crude Oil Futures Contract (WTI) fell as low as -$37. This meant holders of those contracts were willing to pay other traders to take WTI off their hands.
Read more: [Grayscale owner tries to lure ETF buyers by pumping its own Bitcoin stock]
This coincided with an overall crash in oil prices during the first half of 2020. People were traveling less and using less oil during the initial upswing in the COVID-19 pandemic. This had a sharp impact on the value of futures.
Similarly, a Bitcoin bear ETF could hypothetically break if investors extend themselves too far when shorting Bitcoin — or if Bitcoin’s price changes suddenly.
Inverse ETFs abound
Other large short (also known as “inverse”) ETFs include Direxion Daily S&P 500 Bear 3X Shares (SPXS), which manages $368 million in assets and offers an expense ratio of 1.09%.
ProShares, a Direxion competitor, also manages ProShares UltraShort S&P 500 (SDS), which manages $609 million in assets; and ProShares Short Russell 2000 (RWM), which manages $348 million in assets.
The largest inverse ETF is a NASDAQ bear fund, the 3X leveraged ProShares UltraPro Short QQQ. Direxion’s largest inverse ETF is a 3X small cap bear fund.
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