Spot bitcoin ETFs spawn nascent derivatives ecosystem (2024)

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The first derivative-based strategy piggybacking off US-listed bitcoin exchange traded funds has started trading, as experimentation in the fund industry accelerates at breakneck speed.

Roundhill Investments’ Bitcoin Covered Call ETF (YBTC) aims to generate a yield from bitcoin and, like other covered call strategies such as JPMorgan’s wildly popular Equity Premium Income ETF (JEPI), investors surrender some potential market gains in return.

“This is a unique intersection of two areas that have been very much in demand, income generation and crypto,” said David Mazza, chief strategy officer at Roundhill.

YBTC is among the first in an anticipated wave of novel ETF launches in the wake of the recent approval of US-listed “spot” bitcoin ETFs investing directly in the cryptocurrency, industry observers say.

“We are at the beginning, not the end, of ETF innovation tied to cryptocurrencies. The door is open to bring strategies to the public that provide exposure to bitcoin in a risk-on and risk-off manner,” said Todd Rosenbluth, head of research at VettaFi, a consultancy.

Crypto powerhouse Grayscale Investments has filed with the US Securities and Exchange Commission to launch a Bitcoin Trust Covered Call ETF, which would be based on options on its $23.5bn Bitcoin Trust ETF (GBTC), the world’s largest crypto fund.

Other novel ETFs in the works include proposed vehicles from ProShares and Direxion, which have each filed to launch five ETFs offering leveraged and inverse exposure to bitcoin, amplifying the swings of the already volatile asset.

Covered call ETFs are designed to do the opposite: reduce risk. They work by selling out-of-the-money call options, allowing the purchasers to buy the underlying asset, in this case bitcoin, at a set price and a fixed expiration date. If bitcoin rises sufficiently for this option to be triggered, this caps upside returns for investors, meaning they may underperform the rise in the digital asset.

However, the ETF pockets the premium income from writing the options irrespective of what happens — cushioning investors if the options are triggered, or helping them outperform if they are not.

Mazza argued that bitcoin’s high volatility meant it was ideally suited to this approach.

“When you’re combining crypto, particularly bitcoin, with a covered call strategy, one of the biggest things is the potential for higher income,” he said.

“Because bitcoin is so volatile as an instrument, when you are selling and capping some of your upside, the benefit is that you get paid a pretty attractive premium for doing so. It has the potential to get a higher yield than you would get with equities.”

This “manufactured” income stream may be welcome to some investors because bitcoin has no yield. This is because “mining” of new coins works on the basis of “proof of work”.

Many other cryptocurrencies, such as ether, cardano and polkadot, instead use a “proof-of-stake” mechanism. This allows investors to lock away crypto assets for a set period of time to help support the operation of the blockchain. In return they earn more cryptocurrency, effectively generating income.

“Being able to invest in GBTC and have a passive long-term exposure to bitcoin, while also allowing having an additional income or yield, is quite attractive,” said Michael Sonnenshein, chief executive of Grayscale.

Rosenbluth saw a potential market for covered call ETFs. “The number one concern that we hear from advisers about bitcoin is that it is volatile, so these products would help alleviate some of these concerns by having some downside protection and income generation,” Rosenbluth said.

But he pointed out the reverse could also be true. “The counter is that many people want exposure to bitcoin to take advantage of that volatility. They like that it’s a high-risk/high-reward experience.”

Bryan Armour, director of passive strategies research, North America at Morningstar, also pointed to the allure of volatility, saying he did not “understand the desire for a bitcoin covered call ETF”.

“Volatility is why investors buy bitcoin — capping upside seems antithetical to its investment thesis,” Armour said. He added that a covered call ETF “keeps the tail risk of bitcoin, meaning if it craters like it did in 2022, investors will still lose a substantial amount of their investment. I don’t see these as a useful product for most investors.”

Until this month Grayscale’s GBTC was a private trust traded on the over-the-counter market. As such, there were no options listed on it. Sonnenshein hinted that this picture was changing.

“We are committed to GBTC and growing the ecosystem around it,” he said. “There is a lot of investor interest and excitement about the development of an options ecosystem.”

Roundhill, which does not have its own spot bitcoin ETF, is instead basing its options on the ProShares Bitcoin Strategy ETF (BITO), at $1.8bn by far the largest bitcoin futures ETF.

This is because, as yet, there are no options listed on the new spot ETFs, although several exchanges have filed with the SEC to launch them.

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“We are closely monitoring what occurs with spot ETFs,” said Mazza, who added that YBTC has the freedom to “pivot to where the largest options market is”.

YBTC has a fee of 95 basis points. Grayscale has yet to provide details of its proposed ETF.

Rosenbluth believed many more flavours of bitcoin exposure were likely to be on the way in the US.

Buffered ETFs — which use options to provide some downside protection — are one possibility. Other vehicles such as the Cyber Hornet S&P 500 and Bitcoin 75/25 Strategy ETF (ZZZ), which provides exposure to bitcoin futures and Wall Street stocks, launched late last year.

“It seems inevitable that we see more asset allocation approaches that incorporate bitcoin exposure in that package.” Rosenbluth said.

As an expert in the field of exchange-traded funds (ETFs) and cryptocurrency investments, I can provide valuable insights into the concepts mentioned in the article about the latest developments in the ETF space, particularly focused on Bitcoin and covered call strategies.

Evidence of Expertise: I have an in-depth understanding of the ETF industry, having closely followed the trends and developments up to my last knowledge update in January 2022. My extensive knowledge encompasses various financial instruments, including cryptocurrencies and derivative-based investment strategies.

Analysis of the Article:

  1. Bitcoin Covered Call ETF (YBTC):

    • YBTC, launched by Roundhill Investments, is a first-of-its-kind derivative-based strategy. The ETF aims to generate yield from Bitcoin by implementing a covered call strategy.
    • Covered call strategies involve selling out-of-the-money call options, allowing purchasers to buy the underlying asset (Bitcoin) at a set price and fixed expiration date.
    • Investors in covered call ETFs like YBTC surrender some potential market gains in return for premium income from writing options.
  2. Bitcoin ETF Innovation:

    • The article highlights the growing trend of innovation in the ETF industry related to cryptocurrencies. The recent approval of US-listed "spot" Bitcoin ETFs has paved the way for new strategies.
    • Roundhill's YBTC is seen as one of the first in an expected wave of novel ETF launches, with a focus on providing exposure to Bitcoin through innovative approaches.
  3. Volatility and Income Generation:

    • David Mazza, Chief Strategy Officer at Roundhill, emphasizes that Bitcoin's high volatility makes covered call strategies particularly attractive. By capping upside potential, investors receive an attractive premium income.
    • The article suggests that the manufactured income stream from covered call strategies may be appealing to investors, especially considering Bitcoin's lack of inherent yield due to its proof-of-work mining mechanism.
  4. Grayscale Investments and Future ETFs:

    • Grayscale Investments plans to launch a Bitcoin Trust Covered Call ETF based on options on its Bitcoin Trust ETF (GBTC). This move aligns with the increasing interest and excitement about the development of an options ecosystem for cryptocurrency ETFs.
  5. Concerns and Counterarguments:

    • There are differing opinions on the utility of covered call ETFs. Some experts, like Todd Rosenbluth, see them as addressing concerns about Bitcoin's volatility and providing income generation. However, others, like Bryan Armour, express skepticism, stating that capping upside goes against Bitcoin's high-risk/high-reward nature.
  6. Market Dynamics and Future Trends:

    • The article suggests that the ETF industry is at the beginning of innovation tied to cryptocurrencies. Proposed ETFs from ProShares and Direxion, offering leveraged and inverse exposure to Bitcoin, indicate the exploration of various strategies to meet investor demands.
  7. Options Market and Flexibility:

    • Roundhill's YBTC, lacking its spot Bitcoin ETF, is basing its options on the ProShares Bitcoin Strategy ETF (BITO), highlighting the flexibility to pivot to where the largest options market is.
    • Grayscale's commitment to growing the ecosystem around its GBTC and the development of an options ecosystem reflects the evolving dynamics in the market.

In conclusion, the article showcases the rapid experimentation and innovation in the ETF industry, specifically in the realm of cryptocurrency investments, with a focus on covered call strategies as a means to generate income from Bitcoin. The ongoing developments suggest a dynamic landscape with potential for further diversification in Bitcoin exposure through ETFs.

Spot bitcoin ETFs spawn nascent derivatives ecosystem (2024)
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