How much profit did the Bitmex arbitrage make?

19. März 2020

For at least three years now I have been advocating for the Bitmex futures "Cash and Carry" trade which is an arbitrage of the quarterly futures contracts versus the spot price of Bitcoin. With this recent selloff and hedge opportunity I wanted to demonstrate once again how this trade played out and its benefits. I've been telling people to do this not only in period of high volatility but also as a general hedging strategy to "lock in" the VALUE of Bitcoin at any given time that there is an opportunity. I seriously do not think anyone but myself utilizes this strategy because when I explain it to your typical crypto trader they get confused and invariably ask "but how Lambo?" This won't yield sick gainz brah but it will protect your capital!

To recap; a Cash and Carry trade is where one trades a futures contract against its underlying where there is a spread between the two prices. This is an arbitrage trade. Ideally the futures contract will move towards the spot price as time reaches the settlement date. In modern normie markets the spread between futures and spot are too small due to their high liquidity, margin interest requirements, and plenty of other arbitrage traders capturing the minuscule profit potential. This trade still remains though on the Bitmex platform. Bitmex has quarterly futures contracts which can be held without paying the fees of the continuous contract. These will often trade at premiums or discounts to the spot price of BTC. The spread of premium or discount will be largely dependent on market sentiment at that time. When Bitcoin is bullish traders are betting the price to be higher at settlement and the quarterly futures will trade at a premium. The inverse is true in bearish conditions. You can visualize this spread by pasting in "(XBTH20-XBTUSD)/XBTUSD*100" without " " to Tradingview symbol; you can also substitute for other contracts by changing the first symbol.

So what happened in this recent selloff? The important thing here is that we are just trying to lock our BTC value at 0 delta to protect the value against such crashes. We do that by selling the futures contracts equivalent to our account value. Let's assume that when BTC was at around 10k a trader decided that it was time to lock in the USD value of their Bitcoin. Let's say they had 1 BTC in their account to keep it simple. On Februrary 9th the Daily bar closed at 10172 on XBTUSD. The March 27th quarterly futures contract (XBTH20) was trading at 10460. This meant that the quarterly futures were trading at a 2.8% premium to spot.

So the trader Sells -10172 contracts of XBTH20 @ 10460. We want to set the contract size to BTC spot price rather than the futures price to mitigate risk in the event of further premium expansion.

In the weeks that followed the market sells off. By March 12 the premium had inverted to a discount of -4%. We close the trade. At the end our BTC is worth over 57% less than it was at the start but we now own 2.4656 instead of 1. If we then calculate our account value in USD we have $10691. Though BTC is DOWN over half our total holdings value is UP by 5.1%!

Are we going to buy that Lambo this year with 5.1%? Probably not... but we have protected our assets and profited from this rare opportunity! A trader only ever uses 1x leverage to hold the position which means there is plenty of leverage available to trade other contracts while this one position is protecting account value.

A final note about arbitrage opportunities: they always go away. As I've written before about December 2017 bubble the opportunity was around 18%! More recently when BTC dropped from 6500 the premium captured was 8%. This time it was only 5-6%. Slowly this inefficiency is indeed going away. Still, at any given time the futures contracts are trading at a premium this is a virtually riskless trade. Even if one doesn't like taking this trade just watching the spread is still a very useful analysis tool to gauge market sentiment.