Trading Butterfly Spreads

The above referenced articles can be found on the Eqonomics page, should a refresh be needed.

Wonky curves

In an efficient market, you would expect the future price of BTC to monotonically increase or decrease over time. There is no future cash flow, cost of carry, nor seasonality: all factors that could lead to ‘wonky’ curves.

However, markets are not always efficient. Opportunities present themselves if futures contracts are priced richly or cheaply, relative to one another.

Chart 1: Percentage values are the absolute returns of the future versus spot.

Return [%] = ( Dated Future Price – Spot Price ) / Spot Price

To capture these returns, you would go long BTC spot and short the dated future for the same units of BTC. It assumes this carry trade is held until the futures contract expiry, to fully realize that locked-in return. Further information on this type of trade can be found in “Playing The Curve: Part II Yield Strategies”, under the section “What if the curve is in contango?”.

As would be expected, a higher time frame offers a higher absolute return when the curve is in contango.

However, there are quicker ways of identifying the opportunity. If we switch it to an annualized return, a fair comparable across expiries, we can observe the September contract as an outlier.

Chart 2: Bitcoin Futures Implied Annualized Return

Annualized Return [%] = Return / Days to Expiry * 365

Exploiting the kink

To trade the relative cheapness of the September contract, we need to enter a long position. In a butterfly spread trade, we wish to capture a particular point of the curve without assuming a directional view.

To enter the trade:

• Short 0.5 BTC June Dated Future
• Long 1.0 BTC September Dated Future
• Short 0.5 December Dated Future

Chart 3: Trade Positioning

Entering short positions in both June and December mitigates a change in curve steepness. Entering just one of these two contracts short could be loss-making should the curve steepen or flatten, even if September relative pricing reverts.

Chart 4: Positive Scenario

An example, with figures, to better understand the trade mechanics.

Although the curve has flattened and BTC spot price has moved up, the trade is profitable as the curve has reverted to a more regular shape.

This trade would have returned $630 based on an overall position size of 1 BTC long and 1 BTC short. As there is limited directional exposure, this trade can be entered with leverage.

Entering the trade with 5,000 USDC initial margin would result in leverage of around 18.5x and a return on capital of 12.6%.

This trade can also be entered in reverse, should a single contract be priced comparatively rich.

For balance, and to keep Eqonomics on the compliance department’s Christmas card list, should the curve become ‘kinkier’ the position will be loss making. The higher the leverage, the higher the risk of liquidation.

Conclusion

Butterfly spread trading is complex and carries risk but can be an effective way to profit from short-term structural imbalances. In choppy, sideways markets, it offers a way to participate without assuming a direction. If you are new to this concept, size your notional and leverage accordingly.

As we extend our range of futures (hint: very soon!), the scope of opportunity will increase.

Good luck and get in touch if you have questions.

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