A Primer on How Bitcoin Futures Work

BitcoinBrackets – Bitcoin futures launched this evening. This is an exciting step forward, and a step closer to legitimacy, for the currency. Futures can be complicated and confusing, most people have never heard of futures let alone traded futures. The following is a primer to begin understanding. Please read more than just this blog post, which is NOT financial advice, or even guaranteed to be correct, before buying or selling Bitcoin futures.

What are futures?

Futures are derivative instruments that allow for financial bets on real-world assets and indexes. Futures have three main components:

1) An underlying index that represents the price of the asset being traded. This could be the value of the S&P 500, or the price of a barrel of oil, or the price of Bitcoin.
2) An expiration date or settlement date known as a the delivery date. This is the date the the future closes and trader’s gains and losses are paid out.
3) A strike price. The price at which the parties entering the futures contract agree to buy and sell or cash settle the underlying asset at the delivery date.

To explain, let’s use a completely non-realistic example. Imagine there is an index that represents the high temperature in as recorded in Central Park, New York City each day.

Today's Weather from Central Park, New York City.
Today’s Weather from Central Park, New York City.

In August, two traders agreed to bet that the high temperature (the Index) would be 45 degrees (the Strike price) on December 10, 2017 (The Delivery date). They would enter a futures contract to cash settle a contract at 45 degrees. For each degree above that, the short party (the one who sold the contract) would pay the long party (the one who bought the contract) $100. For each degree below 45 degrees, the long party would pay the short party $100.

Today, December 10, 2017, the high temperature recorded in Central Park was 39 degrees. That means the settlement would give the short trader $600 and the long trader would have to pay $600.

Simple right?

For Bitcoin it’s similar. The front month of the futures, the nearest settlement date, has a settlement of January 17, 2018. The underlying index is the Gemini auction price for bitcoin: ticker symbol GXBT. The strike price is where traders are currently agreeing to enter contracts. Here’s a snapshot of the current prices as of this writing (click the image to make it bigger):

Snapshot of current Bitcoin futures prices on December 10, 2017
Snapshot of current Bitcoin futures prices on December 10, 2017

As you can see, the most recently quoted price of GBTX is 16250.00. The most recent trading contract of the January futures traded at a price of 17,920. This implies that the traders think Bitcoin will be up about $1,600 between now and settlement on January 17. If you think that Bitcoin will be higher than that, you’d want to go long and buy the contract at this price. If you think it will be lower then you would want to go short the contract.

Let’s imagine that you bought 1 bitcoin futures contract today. If on January 17, 2018 the GBTX is set at $20,000, your account will be credited $2,180. If GBTX is set at $15,000, your account will be debited $2,920.

Hope that helps!