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Trading Bitcoin: Here Comes the First Swap -- and Official Regulation

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It seems that the Bitcoin market is getting the same kind of attention any market would from derivatives operators.

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There's a growing market of services around Bitcoin, and the world of finance seems to recognize the opportunity this presents. The Wall Street Journal reported a new Bitcoin-related derivative instrument was being developed by Tera Group Inc. The aim of the company is to provide the first Bitcoin swap.

Such an instrument would possibly make it easier for the players in the Bitcoin market to hedge their exposure to the currency (or gain exposure, depending on the type of the player). The first contract will be a 25-day transaction between two US companies from the financial sector. One of the unnamed parties will hope to profit from the appreciation of Bitcoin; the other one will limit its downside.
 
Apart from coming up with this transaction, Tera has reached out to the Commodity Futures Trading Commission (CFTC) to list Bitcoin derivatives on the regulated market. The structure of the Bitcoin swap is supposedly synonymous to the structure of nondeliverable forwards, which could make it easier for the CFTC to accept the contract. The CFTC hasn't expressed its opinion on the matter.
 
It seems that the Bitcoin market is getting the same kind of attention any market would from derivatives operators. Bitcoin swaps or futures could be particularly useful for retailers, who could then limit their exposure to Bitcoin price swings. This might be important if Bitcoin doesn't actually lose any of its wild volatility.
 
While retailers appreciate the ability to take Bitcoin payments without paying processing fees to credit card companies, they don't necessarily want to bear the exchange rate risk -- this is not their area of expertise, and Bitcoin can swing up and down quite significantly. So, retailers might be interested in derivatives with Bitcoin as the underlying asset.
 
On the other hand, swaps or forwards are individual contracts and, as such, might be relatively expensive to enter. The possibility to launch cheaper regulated instruments (e.g., futures) could be what retailers are looking for. The extent to which they would actually be interested in both regulated and unregulated Bitcoin derivatives remains to be seen.
 
Let's move on to the charts.
 

Click to enlarge

Yesterday saw a reversal on strong volume on Bitstamp. The currency went 4.5% up compared with the previous close. The action seemed very bullish, but Bitcoin failed to close above $600 (dashed red line on the chart). Based on yesterday alone, we can't quite proclaim that the move down is over.
 
This is reinforced by the action today at the time of this writing (11:30 a.m. EDT). Bitcoin has gone 1.5% down. The volume hasn't been very heavy yet, but this may change, as the day is far from being over. We're not seeing a confirmation of a move up, though. It looks more like the move up has run out of steam.
 
At this point, the short-term outlook remains unchanged, more bearish than not but not bearish enough to go short just yet. If we don't see any more appreciation today, we will likely consider going short.
 

Click to enlarge

The situation is fairly similar on BTC-e. If anything, Bitcoin gained less yesterday and has lost marginally more today than on Bitstamp. The volume was relatively high yesterday, and it seems that it might be heavy also today (but not extremely heavy by what we've seen until now).

Both yesterday and today, Bitcoin has failed to go above $600, and if it fails to close above this level, we most probably won't see yesterday's action as a valid reversal. If Bitcoin fails to appreciate today, the short-term situation will become bearish and we'll think of going short.
 
Trading position (short-term, my opinion): no positions. If Bitcoin closes the day in the red, we'll consider shorting.

For the full version of this essay and more, visit Sunshine Profits' website.

Mike is a quantitative analyst focused on economic reality, not theoretical models. His investment thinking is grounded in empirical evidence and common sense. A holder of two master's degrees in quantitative methods and finance, he researches economic uncertainty, portfolio management, and investor behavior. At SunshineProfits.com he develops innovative investment tools, and is the author of the Bitcoin Trading Alert service.
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