Help me structure a futures contract (potential bounty)

[yochdog]

I will soon be taking on a large BTC denominated loan, which will be paid back over 5 years.  Obviously, if the price of BTC spikes within that time frame, I am exposed to massive exchange rate risk.  I earn in dollars, but must convert to BTC to pay back the loan. 

I am only interested in guarding against a spike in the exchange rate, not a decline, as that would benefit me as the debtor. 

Bitcoinica offers their trading service with 10:1 leverage, and it seems to me this offers a decent way to hedge away most of my exchange rate risk.  Is it as simple as taking a leveraged long position in BTC equal to my loan amount?  Then the gains from the leveraged long position offset the fact that I am having to pay more dollars for my loan repayments?  Is the only risk if I get stopped out on the downside right before a massive price spike? 

I have extensive professional experience with equity and options trading, but nearly none at all with leveraged futures or BTC speculation.  Anyone that could help explain this further, and point out pitfalls would be greatly appreciated.  Paticularly informative posts will be rewarded with a small bounty, comensurate to the value I find them to provide. 

Thank you in advance!

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[FreeMoney]

No, you could get totally screwed going long 10:1 if the price drops even a bit before it skyrockets. Even 2:1 isn't what you want, plus that would require more hedging capital. You need an option to buy coins at or near the current price in 5 years time. That's not going to be easy to get because anyone who will promise do that for you won't hold them or be able to afford coins if they skyrocket or else they are holding them because they expect them to go way up and will charge you a lot.

For your case I would borrow dollars with an agreement that you can pay them back with bitcoins at the market rate. I don't think anything else is going to match up perfectly with what you want.

[yochdog]

No, you could get totally screwed going long 10:1 if the price drops even a bit before it skyrockets. Even 2:1 isn't what you want, plus that would require more hedging capital. You need an option to buy coins at or near the current price in 5 years time. That's not going to be easy to get because anyone who will promise do that for you won't hold them or be able to afford coins if they skyrocket or else they are holding them because they expect them to go way up and will charge you a lot.

For your case I would borrow dollars with an agreement that you can pay them back with bitcoins at the market rate. I don't think anything else is going to match up perfectly with what you want.

The loan is amortizing, so I do not need to hedge the entire amount 5 years out.  I need to hedge a lot today, but that amount frops over time as the loan pricipal is reduced. 

The loan agreement I have reached is a BTC only loan.  The loan is extended in BTC, and payments are made in BTC.  That is the whole point....we are trying to be BTC centric.....

[Tril]

Pay your partner the bitcoins. He keeps them as collateral and lets you run the company. He agrees to sell the bitcoins back at 5 each if it goes up, BUT you have to give him equity back for the difference. You pay him dollars out of the earnings of the company over time. If bitcoin skyrockets then he will sell the bitcoins to you and get equity, but you can pay your debt. If bitcoins stay the same or become cheaper then you buy them on the market. If the company tanks you have to work for him to earn back your bitcoins!

[FreeMoney]

No, you could get totally screwed going long 10:1 if the price drops even a bit before it skyrockets. Even 2:1 isn't what you want, plus that would require more hedging capital. You need an option to buy coins at or near the current price in 5 years time. That's not going to be easy to get because anyone who will promise do that for you won't hold them or be able to afford coins if they skyrocket or else they are holding them because they expect them to go way up and will charge you a lot.

For your case I would borrow dollars with an agreement that you can pay them back with bitcoins at the market rate. I don't think anything else is going to match up perfectly with what you want.

The loan is amortizing, so I do not need to hedge the entire amount 5 years out.  I need to hedge a lot today, but that amount frops over time as the loan pricipal is reduced. 

The loan agreement I have reached is a BTC only loan.  The loan is extended in BTC, and payments are made in BTC.  That is the whole point....we are trying to be BTC centric.....

I understand wanting to be bitcoin centric, but borrowing in terms of coin is going to potentially leave you (I know you know obviously). The cleanest way to cancel the bad effects of borrowing coin would be to go borrow some dollars and use them to buy the coin so you'll be sure to have it when you need it.

[guruvan]

If you just want to guard against month to month spikes, you could head over to MPOE http://polimedia.us/bitcoin/options.php and buy call options - he's offering 1,2,3 month maturities. The ordering system is not simple

Bitcoinica won't work as well as you'd like - the position is a leveraged one in which you never take delivery of actual coin - you'd profit on the rise of coin, but have to buy coin then, costing you at least the difference in the spread at the time of position exit & exchange to BTC. The 10:1 leverage option doesn't allow for the size account you'd need ($2k max)

There might be a few people around who'd talk about options with later maturity dates. If I were going to work out an options contract long term, I'd need guarantees that the counterparty had the coin locked up until the maturity date (i.e. a long term CD with a reputable bitcoin banker)

Because there's so much uncertainty about the long term exchange rate, 3mo options may be all you'd really want - your counterparty's risk on a longer term option would likely increase the premiums too much.

Seems another way to hedge the risk (partially) is by shopping for inexpensive mining contracts/bonds (lol, while still reselling your hash power) If you can pay for this in USD you might have it made

EDIT: but if you have experience trading, it seems that you could do well to start a $2K USD funded account, w/ a long position with minimal initial capital risk, build that position on dips & rallies (as the position show more profit, add on to it, using profit equity as additional risk capital - as long as you limit the risk on the position to say 10% of capital, you can take a lot of downside, which doesn't hurt you too much, and with only a small amount of actual risk, you have little chance of force liquidation. When the account size grows, you'll have to cash some or all of the position out, and go to 5:1 until Bitcoinica has more capital to offer as leverage. The less you touch that trade the better, I'd think

I actually think bitcoinica could work very well for an experience person, using limited risk, and a very long term strategy on a long position. you can't hedge your whole loan this way, but it would help.

[Shuai]

It's cool you're trying to btc centric and all.

But don't do this, there's no way you can hedge against it and there's a huge chance that the outcome will end out being super shitty for one of you.

[N12]

The 10:1 leverage option doesn't allow for the size account you'd need ($2k max)

Yes it does, you can create as many accounts anonymously as you like. The problem is that there is a near 100% chance he will get zhoutonged and lose all his funds on a dip down (you get liquidated at maybe 6% down from your base price).

I think taking a big very long-term loan in Bitcoins is a bad idea too, I can’t imagine there being any way to hedge against a price rise efficiently.

[guruvan]

The 10:1 leverage option doesn't allow for the size account you'd need ($2k max)

Yes it does, you can create as many accounts anonymously as you like. The problem is that there is a near 100% chance he will get zhoutonged and lose all his funds on a dip down (you get liquidated at maybe 6% down from your base price).

I think taking a big very long-term loan in Bitcoins is a bad idea too, I can’t imagine there being any way to hedge against a price rise efficiently.

At the amount of risk I was suggesting, BTC would have to drop to almost in half to liquidate a position. That'd be a hell of a dip! (I don't understand why people try to max out the account on a position, it's asking for trouble)

Funding account w/ 2K @ 10:1 = 20K Tradable, use 2K/BTC-ask=risk amount. You can handle much more than a 6% drop this way.

I would not use anonymous, unverified accounts for long term money. Possible risk of unrecoverability seems greater to me than liquidation risk.

I tend to agree that long term BTC loan is a risky proposition, but I do see ways you could do it. Very difficult to hedge it for long periods of time - so many variables and unknowns. 

[N12]

At the amount of risk I was suggesting, BTC would have to drop to almost in half to liquidate a position. That'd be a hell of a dip! (I don't understand why people try to max out the account on a position, it's asking for trouble)

Funding account w/ 2K @ 10:1 = 20K Tradable, use 2K/BTC-ask=risk amount. You can handle much more than a 6% drop this way.

Then you simply wouldn’t be leveraged 10:1. It’s just the ratio of your reserves and the margin you use for your position, nothing else. You can’t use margin as a reserve on your account.

The leverage setting only determines your maximum allowed leverage.

Correct me if I understood something horribly wrong.

[guruvan]

At the amount of risk I was suggesting, BTC would have to drop to almost in half to liquidate a position. That'd be a hell of a dip! (I don't understand why people try to max out the account on a position, it's asking for trouble)

Funding account w/ 2K @ 10:1 = 20K Tradable, use 2K/BTC-ask=risk amount. You can handle much more than a 6% drop this way.

Then you simply wouldn’t be leveraged 10:1. It’s just the ratio of your reserves and the margin you use for your position, nothing else. You can’t use margin as a reserve on your account.

The leverage setting only determines your maximum allowed leverage.

Correct me if I understood something horribly wrong.

I didn't suggest leveraging the funds 10:1. I suggested using 10:1 leverage for a $2K account, and starting with a position valued at $2K. (this is a 1:1 bet, with 10:1 leverage to protect from downside) as the position value grows, continue to add to it in the same ratio (1:1, add your profits to the position) In this scenario, you'd buy put options to protect from significant downside, and set a stoploss way down to prevent liquidation (but also preventing your position from getting stopped out on a short term dip)

Since you're looking for a very high long term reward from the position, the acceptable downside on the position is increased, as it's likely viewed as temporary (i.e. I'm not worried at the moment if BTC hits $4, I have confidence in the future, so I accept a great deal of downside risk, and try to keep the ratio at 1:2 risk:reward, so I'm looking for significant upside.

Having 10:1 leverage, and using 100% of your available leverage seem to me to be different. I use the margin in my account as cushion against the downside (and drawdown from it). I would never recommend that someone enter a position valued at $20K on a 10:1 $2K account. It is probably a faster way to lose money than matches and gasoline.

If I wanted to enter a position that leveraged my funds 10:1 I'd want a 100:1 margin account.

Hopefully this is more clear. A more risk tolerant person might take a larger position, but I would recommend against it for all but the most aggressive and experienced traders.