Cryptocurrency-related investment strategies
A guide to Futures, ETFs, Options, and Covered Calls.
In 2021, after the SEC had approved the creation and sale of Bitcoin Future-based ETFs, the ProShares Bitcoin Strategy ETF was put up on the market, where it raised over $1.2bn within a few days.¹ It allowed institutional investors, money managers, and advisors access to Bitcoin exposure on their portfolios. It was actually possible for this to happen earlier, through investment in Bitcoin futures contracts, which had been available since 2017. However, due to the amount of management required and the possibility of price manipulation at the time, their release met with muted fanfare.²
Various DeFi options had also existed at that point that had directly purchased Bitcoin, allowing them to offer yield through selling covered calls on the underlying assets, a big draw for those heavily into cryptocurrencies.
It’s in this article, we’re going to be looking at how some of the concepts I’ve mentioned above work in order to help you understand the basics of Futures, ETFs, Options and Covered Calls. In the conclusion, we’ll also be weighing up various existing ETFs and how they’ve performed against some popular “traditional” ETFs.
Futures
Futures contracts, or “futures,” are an agreement between two parties to buy and sell a certain commodity or asset at a set price (delivery price) on a set day in the future. Depending on the settlement date and the current market price of that asset (known as spot price), the market price of futures fluctuates (based on the lowest priced contract near spot).
As the price of futures depend on the type of contract, daily futures prices are based on “front month” futures prices, meaning the lowest market price of soon-to-expire contracts.
Futures contracts can also be “cash-settled,” meaning no physical transfer of commodities/assets takes place, you simply get paid or pay the difference between the delivery price and the spot price on expiration.
ETFs (Exchange Traded Funds)
Traditional ETFs are funds that track a particular set of stocks, mainly according to an index or type of industry. There are also single stock ETFs that have emerged but are usually used as a vehicle for leveraged investment, and we can ignore them in our description of ETFs in general.³
When investing in an ETF, either directly off the issuer or by buying one on the market, you are essentially exposing yourself (gaining/losing your money on price movements) to whatever stocks that fund is made up of. You can trade this ETF share as you would with ordinary stocks, as well as “redeem” the share with the issue for the underlying assets. ETFs also generate yield due to dividend payments from the underlying stocks.
ETFs that are based on futures prices work slightly differently. Many futures-based ETFs track the forward price* of cash-settled futures, meaning they can’t be redeemed for the stock/commodity itself. It also means they don’t generate yield, as owning futures contracts doesn’t pay dividends.
(*Forward price = Market price of front-month futures.)
Although there’s been a demand for bitcoin-settled ETFs in the US, the SEC hasn’t allowed one onto the market yet.
However, in Canada, the investment management firm Purpose Investment was given permission to release the world’s first one.⁴ Interestingly, although it can’t generate yield the traditional way, because the fund physically owns bitcoin, they are able to utilise covered calls instead to offer yield incentives to investors.
Covered Calls & Options
Covered calls are a strategy of writing call options on stock/assets you own. Options contracts are an agreement that gives the contract holder the right (not the obligation like futures) to buy or sell the underlying asset at a fixed price point (or “strike price”) from the contract writer until a certain date. Options tend to contain 100 shares and are priced according to their strike price, duration, and volatility of the underlying. Call options are to buy the underlying, while put options are to sell the underlying at the strike price.
The cost of buying a contract from a contract writer comes at a premium, an offset to the risk of loss of potential profit if the underlying moves against them. It’s this premium that generates yield in the covered call strategy. Covered calls shine the most in times of price stability and gradual upward movement and act as a hedge during market declines. If you expect rapid price appreciation, you would benefit from a different strategy due to the way calls work.⁵
DeFi Covered Call Strategies
Until now, we’ve discussed ETFs available through traditional financial means, but there lies a different option for those who aren’t accredited investors or would like to do the same strategy using DeFi only. Projects such as StakeDAO or Ribbon Finance offer covered call strategies that accept Ethereum or Bitcoin payments. Although these strategies aren’t ETFs themselves, they utilise your crypto deposits to generate yield in the same way. Your yield is also automatically re-invested, requires no KYC and is not subject to traditional tax laws regarding investing in a fund.
Conclusion
There’s no such thing as a free lunch in finance, DeFi or otherwise. ETFs that offer yield have their positives and negatives depending on the market and your expectations. I hope that this article has helped you understand some of the interesting ideas and strategies surrounding cryptocurrencies and dispel some of the mysteries of finance.
References:
[1] https://citywireusa.com/professional-buyer/news/proshares-reaps-first-mover-advantage-as-investors-await-spot-bitcoin-etf/a1574837
[3] https://www.ft.com/content/f7074f22-5e54-4042-834f-4bfcf393752b
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