So heres my situation - I need to buy $650 of BTC to make a purchase costing $650. I figure the cheapest method is through circle or coinbase which I've decided to use circle as it looks like coinbase cancels all of your purchases if you're new and get lucky - currency going up in value speaking.
What is the best option I have?
There's no real properly priced options contracts out there on bitcoin, futures on the other hand are getting popular.
But let me walk you through an example for hedging the downside risk of the $650 using futures contracts, using the
highly liquid futures exchange OKCoin at 10x leverage:
First, you're hedging the downside risk, so you're going to want to SELL futures (i know you said you're a finance major but I just wanted to state this explicitly for the sake of others reaing this).
OK Coin offers futures contracts denominated by $100, with 10x leverage.
Let's say for simplicity sake that the market price of bitcoin is $250.
So you are purchasing 2.6 bitcoins ($650) and you want to make sure that if the market price drops, you still have $650 worth of bitcoin.
To demonstrate how many contracts you have to sell to completely hedge, consider the price dropping from $250 to $200.
Your 2.6btc is now worth only $520! So you need 3.25 bitcoins at $200 to have the full $650 you need. You need 0.65 bitcoin more in this case, so this is the target profit from the futures selling.
The drop in USD price was 20%. And at 10x leverage you will be getting 200% return on futures sold for the hedge. Thus you will need to put down 0.216 btc in futures to protect from this downside risk.
Note that all btc futures are transacted and settled in BITCOIN, not dollars, but the contract is denominated as $100 for simplicityConversely, you can use 20x leveraged contracts and use only 0.108 btc worth...but then you run the risk that maybe price goes up 5%, followed by a major dump, which leaves you with a loss on your hedge AND a diminished purchasing power of the coins. So 10x is probably a safer way to hedge.
So now you have to think to yourself, is it worth it to spend the 0.108 or 0.216 to sell futures to avoid the downside risk of bitcoin action? In the case of a 20% drop, you would save anywhere from 0.4-0.5btc.
However, if the price doesn't go crazy, or it goes up, you will end up having spent 0.1-0.2 btc which you can see as "insurance cost".
Note that because when you're shorting bitcoin you are settling in bitcoin, the farther down the price goes, the less your settled futures will be worth in USD, thus there is a NONLINEAR relationship between how much you should hedge and what you think the price decline will be. So if you expect a 10% drop, then 2.6btc will be worth $585 and you will need 0.288 btc more to get $650. So in that case you put down 0.144btc worth of futures (at 10x, divide by two if you want to save money but take a risk with 20) instead of 0.216btc if you dont think the swing will be more than 10%.
If you use higher leverage futures, you will save money, and can spend as little as 0.077 (if you think the price decrease wont be more than 10%) which would only be 3% on top of the 2.6btc you are buying. Compared to the 5% number you used for LBC, it would make more sense to hedge using futures than to spend higher fees getting it same-day from there. But again, this is a nonlinear hedge, you need to consider just what scenario youre planning for, how much leverage youre willing to use, and then you could be spending anywhere as high as 8-9% to hedge, when you could just as easily wait and spend less than that to get it sameday.
You might also consider just doing a bank transfer to BitStamp or
Coinbase or
BitFinex
, which will take a couple days, and then you can buy at spot price.
I hope this makes sense, I can show you in algebraic detail how to come up with the numbers but I thought walking through an example would be the easiest way.
