What's the most tempting thing about investing in cryptocurrency? For many traders, it's being able to do it using futures.
Little by little, it is becoming easier to do just that. You can do it directly through futures contracts. And you can do it indirectly through exchange traded funds.
Here are answers to your questions about investing in cryptocurrency futures.
Cryptocurrency Futures: Why Investors Use Them
Q: Why trade cryptocurrency futures?
A: Because futures give an investor exposure to at least some of the potential gains of cryptocurrency. Yet futures relieve an investor of certain burdens and risks of crypto itself.
For tips about how to bet on cryptocurrencies in your IRA or 401(k), read this IBD report.
Q: What does buying crypto futures on margin mean?
A: CME Group, a major exchange where cryptocurrency futures trade in the U.S., requires investors to trade crypto futures through futures commission merchants (FCM). An FCM is like a broker-dealer for trading futures, says JB Mackenzie, managing director at Charles Schwab Futures and Forex, an FCM.
FCMs are allowed to set margin levels for crypto futures traders, Mackenzie says. "Margin" is the amount of cash that an investor must pay for a futures contract. The margin amount is often much less than the contract's actual or notional value. When it is less, the investor is being allowed to bet on a futures contract for a discount price.
How Crypto Futures Cut Risk
Q: What sorts of risk do cryptocurrency futures avoid?
A: Take buying on margin. Futures investors have the opportunity to gain from any upside.
But with many conventional commodities like oil, futures traders buying on margin must have enough money on hand to cover any loss in excess of the amount they ante up.
In contrast, with crypto futures, once the dollar balance of a margin amount has been reduced nearly to zero by a pullback in the value of the cryptocurrency, the investor's crypto position typically is closed down, says Bryan Routledge, associate professor of finance at Carnegie Mellon University's Tepper School of Business. The investor is not asked to make good on the additional loss.
Q: Why is a cryptocurrency futures margin position whose value is falling closed or liquidated before its value hits zero?
A: Enough money must remain in the account to pay any transaction fee or other fee that the exchange levies, Routledge says.
Many traders avoid the risk of having their position tank to zero by placing a stop-loss order on it. A stop-loss order directs your broker or exchange to sell your position if your position's value hits a specific level below your initial cost or cost basis.
Do Crypto Futures Move In Lockstep With Cryptos?
Q: Do cryptocurrency futures rise and fall in lockstep with the underlying cryptocurrency?
A: Often, moves up or down are not in total sync. Futures and ETFs that hold futures can rise or fall in value at a different rate than the underlying cryptocurrency does.
First of all, futures themselves may not move in total sync with their underlying cryptocurrency.
Secondly, an ETF holds many futures contracts. Each may have a different expiration date. Older contracts may have moved more or less than Bitcoin itself is moving today.
Q: Is there a simpler way to invest in cryptocurrency futures?
A: You can simplify your bets on crypto futures by using exchange traded funds (ETFs) that specialize in futures. You get the benefits of potential price gains. But you leave the hassles and coping with intricacies to professional money managers.
Q: What are the additional benefits of investing in cryptocurrency futures? Why not just invest directly in cryptocurrency?
A: Futures tend to be safer and easier to invest in than cryptocurrency itself. That's because a crypto futures trader generally does not take ownership of the underlying asset, the cryptocurrency itself. In turn, that eliminates several potential hassles.
Risks That Futures Avoid
Q: What complications does it eliminate?
A: "You don't have to store crypto if you trade in futures," said Schwab's Mackenzie.
Simeon Hyman, global investment strategist for ProShares, which runs the Bitcoin Strategy ETF, points out that a futures trader does not have to worry about losing access to the underlying cryptocurrency if he or she loses their crypto key, the mandatory password for accessing the asset.
BITO is up 4.19% so far this year as of Tuesday, vs. a 3.67% loss by the S&P 500, according to Morningstar Direct.
Q: What other potential benefits do cryptocurrency futures offer?
A: When you buy a futures contract on margin, you often only have to put up a small percentage of the total value of the futures contract you invest in. For example, you may have to put up only $5,000 for a contract worth $100,000.
Q: What determines how big or small a margin payment is?
A: FCMs decide how much margin they require for cryptocurrency futures trading. Crypto futures margins may vary from one FCM to another, says Mackenzie.
And since one cryptocurrency may be more volatile than another, margin requirements can vary from one currency to another.
Further, an FCM can adjust margin requirements throughout a day. "And the size of margin may change due to the volatility of a cryptocurrency's market," Mackenzie said. The FCM can even eliminate margin entirely. If the dollar balance of a margin account has been reduced to nearly zero, the FCM will typically close the account down, in which case the investor is not asked to make good on the additional loss.
ETFs That Focus On Cryptocurrency
Q: What are some ETFs that focus on cryptocurrency?
A: BITO is one. Another is Valkyrie Bitcoin Strategy. Both invest in bitcoin futures rather than in the cryptocurrency itself. BITO has $1.3 billion in assets. BTF has just $45.8 million in assets. Both charge annual expense ratios of 0.95%.
BTF is up 4.56% so far this year.
Q: Can I bet on cryptocurrency price declines using futures?
A: Yes. You can use them to short crypto if you want to bet on a price decline. Likewise, you can invest in an ETF that shorts crypto futures. One such fund is BetaPro Inverse Bitcoin ETF. But beware. This ETF is only $20.6 million in size. In ETFs, bigger is generally better and safer. Larger ETFs have better economies of scale to lower their costs. And ETFs are considered more likely to survive only if they are larger than $100 million.
BITI is down 15.97% so far this year.
Q: Are there any additional ways to play cryptocurrency futures?
A: Yes, some ETFs invest in cryptocurrency futures as well as other securities. This gives you the benefit of diversification. Christian Magoon, CEO of Amplify ETFs, says his firm's Inflation Fighter ETF, which opened Feb. 1, invests in stocks and commodities that seek to benefit from inflation.
Bitcoin is one of the ETF's commodities. Its only cryptocurrency now is Bitcoin. Bitcoin's total weight in the portfolio is 6.17%. Its exposure to Bitcoin is in the form of futures.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and actively run portfolios that consistently outperform and rank among the best mutual funds.
