The Optimal Hedge for 2021

(From the January 4th, 2021 Austere Capital Newsletter)

…From a fundamental perspective, BTC is the investment of the 2020s. With the incoming potential Biden Administration's free trade/open border/China-friendly attitudes, the macroeconomist inside of me is strongly shying away from anything dollar denominated.

Coupled with a completely trigger-loose Fed and similar monetary policies from Central Banks globally, it's no wonder why institutions like MicroStrategy have begun dumping their cash into Bitcoin.

Also, what's the ideal trade for 2021 if you simply want to remain long BTC?

Long BTC, hedged with 3 month put contracts.

Why? Let's explore two brief scenarios below.

Scenario 1: Long 100 BTC only.

BTC price drops down to $24,000 from current spot (as of this writing) of $31,000. For a portfolio of 100 BTC that's a loss of $700,000. You sit and wait in hope for the price to begin another bull run.

Scenario 1 Result: Loss of $700,000.

Scenario 2: Long BTC, hedged with 3 month put contracts.

We hedge with March 2021 puts at the $24k strike. Current prices on Deribit are listed at ~2000/contract. We want to fully hedge so we buy 100 of these for a total hedge cost of $200,000 (to cover our 100 BTC).

The total hedge cost as a % of your total portfolio value will be ($200,000) / (100 * $31,000) or ~6.5%.
(Note that puts recently became expensive just today since BTC dropped from 33k to 31k recently.)

If BTC goes up to $33,000, your hedge cost is already compensated for.

If BTC drops to $24,000 your initial $700,000 loss will be partially (or fully depending on the severity of the price drop) offset by the increase in value of the puts.

If BTC drops below $24,000, we can exercise the puts to retain capital (i.e. $24,000 * 100 = $2.4MM). We can then buy back in at lower prices once the spot price stabilizes, say around $20,000. If we buy back in at $20,000 we will accumulate 120 BTC.

When prices rise again to $31k we will now hold 120 BTC, for a total portfolio value of $3.72MM (an increase of $710,000 over our original 100 BTC or $3.1MM).

Scenario 2 Result: Loss (minimal, depending on price drop). Accumulation of additional 20 BTC should price drop below $24,000.

Thus, if you are simply long BTC, you are leaving money on the table each and every time the price goes down.

Say we want to remain long BTC, hedge as above, AND acquire additional BTC as the price drops?

This is what our hedging guide touches upon. To implement this we have to add an additional step: sell puts at particular strikes above our long put strike. We also would need additional capital ready to be deployed should the spot price decline to those strikes.

For additional info, reach out to us here.

(Note: this is NOT investment advice.)