@ Bergman
2024-12-31 14:14:16
## Disclaimer
Not financial advice. This is for educational purposes only. Do your own research. You are responsible for your own choices. The author is not a professional trader and/or financial advisor, only a student of the markets. Act accordingly.
## Intro
I wanted to explore some opportunities using Bitcoin options in combination with price models. Like a student, I aim to think it through by writing it down. Any feedback is welcome—I’m eager to learn.
## Gold as a standard for financial measurement
There are people who can describe far more eloquently why the U.S. Dollar isn’t the ideal tool for measurement. Gold, due to its unique properties, is one of the best—though not perfect—financial tools to use as a measure for various reasons. Personally, I prefer to measure the adoption of the Bitcoin network against gold, and I believe the ultimate metric for measuring adoption is price.
## Worst Case Scenario
For this exploration, I want to focus on downside risk. The chart above shows that the price of Bitcoin, expressed in gold ounces, follows a power law. Before I continue, I want to state the obvious: the “power law” is not a certainty. As British statistician George E. P. Box famously said, “All models are wrong, but some are useful.” Let’s assume that if the rate of network adoption in the coming year is equal to or greater than in previous years, the power law will retain its validity. The chart shows that the price usually falls to negative 1 standard deviation during a bear market. However, in some cases, such as the bear market of 2022, the price even reached negative 1.5 standard deviations.
In the opportunity example, I will examine the option expiration date of December 26, 2025. Since the chart isn’t interactive, you can’t hover over the lines to get the exact numbers, so I will state them here. According to the Power Law, the price of Bitcoin expressed in gold ounces on December 31, 2025, is 33.4 ounces for -1 sigma and 26.6 ounces for -1.5 sigma.
Depending on your expectations for the price of one ounce of gold on December 26, 2025, you can calculate the bear market bottom in the event of an unexpected downturn of the market next year. Based on today’s gold price, this would be 33.4 x $2,600 = $86,840 for a -1 sigma move and 26.6 x $2,600 = $69,160 for a -1.5 sigma move down. You could argue that the price of gold might be lower if an unexpected bear market begins for risk-on assets. The question is whether gold will be lower or even higher in such an environment. Currently, gold is being purchased as a hedge against inflation and wealth confiscation (e.g., as seen when the U.S. froze Russian state-owned U.S. Treasury bonds). However, in a bear market, it could also be bought as a safe haven during an economic downturn.
## Example
With these numbers in mind, we can explore the option chain on platforms like Deribit. For this example I’m looking at BTC-26DEC25. As of today, December 31, 2024, the futures price for this expiration date is approximately $104,000.
Let’s say you’re a HODLER who believes the current bull market isn’t over yet. You own spot Bitcoin, which essentially means you are long Bitcoin and short dollars. For simplicity, let’s assume you own 1 whole Bitcoin. Since you believe the bull market has further to run, you don’t want to sell your Bitcoin (or perhaps you never want to), but you’re interested in opportunities to stack more Bitcoin.
One option is to pledge your Bitcoin as collateral on the Deribit exchange, giving you enough margin to open a position. This way, you won’t have to sell your Bitcoin but can still participate in new trades. For example, you could sell a put with a $90,000 strike price for, say, 0.16 BTC. At the current spot price, that’s approximately $15,000.
<img src="https://blossom.primal.net/a0ee29e59035e9aa5556e4464941953be2707a74ee39d5c8f4fa5b1988d495c2.png">
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Note that you potentially could earn more by selling a put with a $100,000 strike price, where the extrinsic value is larger. However, I’m choosing $90,000 because it aligns more closely with $86,840, which provides greater room for an unexpected downturn in the market toward the -1 sigma move.
By holding onto your spot Bitcoin, you still retain all the upside potential in case the bull market continues. Selling the put doesn’t require you to take on excessive risk—you’re already long on Bitcoin. If the Power Law holds, it’s probable that the price will remain above $90,000 by December 26, 2025.
Historically, the price of Bitcoin tends to reset toward the Short-Term Holder (STH) cost basis during bull markets. Currently, the STH cost basis is around $87,000. If this happens, it could present an even better opportunity. You could stick with a strike price of $90,000 and collect a larger premium, thereby lowering your breakeven price, or you could aim for the same premium amount and choose a lower strike price, which would reduce your breakeven price even further. However, it’s not guaranteed that you’ll get that chance.
## Risk Management
There are risks involved in this trade. These risks include third-party risks, where Deribit might lose your Bitcoin and be unable to pay it back. The biggest risk is that the adoption of the bitcoin network stalls and the power law gets invalidated to the downside and the price of bitcoin ends up way below your strike price. Another risk of this trade lies in the fact that your collateral is held in BTC, while your trade also depends on Bitcoin moving sideways or upward. If Bitcoin’s price declines, your collateral will lose value. In the event of a market crash, like a black swan event, the market could move significantly against your trade, the put option will go in the money and acquire intrinsic value, which is unfavorable for the seller of the put. In extreme cases, you could face a margin call, requiring you to pledge more collateral, or the exchange could liquidate your Bitcoin and close your position. The bitcoin price could recover and still end up above $ 90,000 at the end of 2025, but you’ll end up with none.
To mitigate this risk—not entirely, but partially—you could sell some spot Bitcoin. Let’s say your goal is to end up with at least 1 Bitcoin. You could sell an amount equivalent to the premium you would receive if the price closes above $90,000. In this case, you would sell 0.16 BTC, resulting in a balance of 0.84 BTC and $15,000. This strategy protects you somewhat if Bitcoin’s price drops, as the premium you receive (denominated in BTC) would be worth less. If the price closes above $90,000, you will still end up with 1 BTC and $15,000. Essentially, you’re sacrificing some upside potential in exchange for added certainty.
If you’re an experienced trader, you could temporarily hedge your position to delta neutral in uncertain periods by shorting the bitcoin future price with the corresponding expiration date. The risk here is that a trader could wind up losing all his potential profit or worse through ‘a death by a thousand cuts’.
It’s important to note that your breakeven price in this trade is $90,000 - $15,000 = $75,000. Additionally, the worst-case scenario, though unlikely, is a -1.5 sigma move, which could bring the price (depending on the USD price of an ounce of gold at the time of expiration) to around $70,000. While this doesn’t eliminate all risk, if you believe the adoption rate of the bitcoin network will stay the same (at worst) and thus the power law won’t be invalidated and so you believe in Bitcoin’s value and its bright future, this represents an asymmetric bet where the probable outcome of gaining $15,000 outweighs the improbable outcome of losing $5,000.
## Your own assessment
Uncertainty is the name of the game—it’s the very reason why premiums and insurance exist in the first place. Nothing is certain; even the presence of the sun could one day vanish. However, you can turn this uncertainty into your ally rather than your enemy. Do your own research and make your own assessment. Ask yourself: what do you think 2025 will bring?
- What will be the yield on the 10-year Treasury Note, a.k.a. the “risk-free rate”?
- Will inflation remain sticky?
- Will AI drive significant productivity gains?
- Will growth outpace inflation?
- What will be the impact of reduced immigration on the labor market?
- Will the Trump administration deliver on its promises?
- What if the U.S. Dollar becomes too strong?
- Will central banks extend their balance sheets further?
- Will governments take on even more debt?
- Will Bitcoin play a bigger role in corporate treasury strategies?
- Will more Nation States adopt Bitcoin?
- Can this train be stopped?
Use your own assessment alongside pricing models like the BTC/Gold oz Power Law. What do you consider probable, and what do you consider improbable?
To summarize, and based on the assumptions stated earlier, this represents an asymmetric bet where the outcome of gaining $15,000 has an estimated probability of around 70%, as a -1 sigma move aligns closely with the strike price. The probability of breaking even is approximately 80%, while there is a 20% chance of losing $5,000 or more. These probabilities\* are based solely on the Bitcoin/Gold oz power law. Your own 2025 assessment could either enhance these odds or make the outcome less probable.
\*Please note that the outcomes of the power law are not normally distributed but positively skewed. The chances are better than described above. [Source](https://open.substack.com/pub/stephenperrenod/p/bitcoin-power-law-vs-gold-mid-2024?r=fo8i&utm_campaign=post&utm_medium=web&showWelcomeOnShare=true)