13 Minute Read

Options Theory: BITO- The New Bitcoin ETF

October 21, 2021

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We’re making progress. After years of waiting for a legitimate Bitcoin ETF in the U.S., we just got one. Kinda. This week, ProShares launched the world’s first futures-based Bitcoin ETF. It’s called the ProShares Bitcoin Strategy ETF (BITO).

The markets’ appetite was ravenous. More than 20 million shares changed hands during Tuesday’s, making it the second-busiest ETF launch in history. Rest assured, the red-hot demand is causing other fund providers to fast-track their own versions. In fact, VanEck has a futures-based Bitcoin fund that is coming to market “as soon as practicable.” The Bitcoin Strategy ETF (XBTF) will compete with BITO for assets.

I had a chance to dig into the prospectus to see what BITO was all about. Here are the 3 key things you should know.

  • It doesn’t track the spot price of Bitcoin, it tracks the front-month futures contract.
  • Its performance can deviate from that of bitcoin prices due to two key variables.
  • The adverse impact of the negative roll yield is a long-term phenomenon.

Let’s take a closer look at each.

Futures, not Spot

When you buy Bitcoin (or any Crypto, for that matter) through Robinhood, Coinbase, BlockFi, Tastyworks, and the like – you’re buying the digital currency directly.

In 2017, when Bitcoin futures launched, it became possible to track and trade derivatives on the cryptocurrency. While tied to the value or “spot price” of Bitcoin, these futures contracts don’t always move in lockstep. The time element (i.e., different expiration dates) and other quirks of futures contract pricing make Bitcoin futures an imperfect proxy or substitute for buying the digital currency directly.

Thus, any ETF that owns Bitcoin futures (like BITO!) can deviate from the actual movement of Bitcoin. ProShares explicitly states this at the top of the funds home page:

“ProShares Bitcoin Strategy ETF (BITO) is the first U.S. bitcoin-linked ETF offering investors an opportunity to gain exposure to bitcoin returns in a convenient, liquid and transparent way. The Fund seeks to provide capital appreciation primarily through managed exposure to bitcoin futures contracts.

The fund does not invest directly in bitcoin

The price and performance of bitcoin futures should be expected to differ from the current “spot” price of bitcoin”


Two Causes of Deviation

A perfect Bitcoin ETF would own buy Bitcoin directly and have an extremely low expense ratio. Its performance would perfectly track the spot price less a few basis points for the expense ratio. In formula form, we would say:

Pure Bitcoin ETF = Bitcoin – expense ratio

But regulators haven’t seen fit to greenlight a pure Bitcoin ETF. They’ve rejected more submissions than I can count.

In the gold markets, GLD is a pure gold ETF. It’s able to perfectly mirror the daily movements in gold because it buys the commodity directly. Thus,

Pure Gold ETF (GLD) = Gold – expense ratio

BITO is a bit more complicated because it uses futures contracts to get exposure. The problem is two-fold. First, futures contracts’ performance can deviate from that of actual Bitcoin. Second, they expire and thus require constant “rolling” to maintain exposure. And herein lies the rub. Longer-dated contracts are usually more expensive than shorter-dated ones; a phenomenon known as contango. As a result, the fund incurs a cost each time it has to roll, which can cause it to underperform the spot price of Bitcoin over time.

The fund’s prospectus cites this as one of the risks.

Veteran traders familiar with USO and its deviation from crude oil futures know that it suffers from a similar problem. In fact, I wrote an entire newsletter about the issue titled USO and the Oil Riddle.

If I were to describe BITO’s performance in a formula it would look like this:

BITO = /BTC – negative roll yield – expense ratio

For the unaware, /BTC is the ticker for bitcoin futures, and “negative roll yield” refers to the drag caused by monthly rolling.

Long-Term Impact

The adverse impact of rolling isn’t visible in the short run. Like a tiny leak in your car tire, it’s unnoticeable each day. But over time, it weighs on the performance. The best way to see it is to wait a few months and then overlay BITO with /BTC.

I used to do the same thing with USO and /CL to illustrate the difference.

Bottom line: I think BITO will be a good vehicle for getting exposure to bitcoin for short-term plays. But, if you want to buy and hold it for years as a bitcoin proxy, you’re better off buying the crypto directly.

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