NewBloc Investment Research: Exploring Bitcoin Miners’ Option Strategy Portfolios

The author of this article is Barry, a strategy analyst at New Bloc, who has 5 years of trading experience in the foreign exchange and gold markets.

As Bitcoin attracts more and more attention from global investors, the mining industry, which is at the upstream of the field, has also been favored by institutions. We know that the cost of mining includes the price and consumption of mining machines. As the electricity cost of mining machines and the computing power of the entire Bitcoin network continue to increase, the difficulty of mining will become greater and greater, and the payback period will also become longer.

For Bitcoin miners, the longer it takes to recover their investment, the greater the risk of price fluctuations they will have to bear. Therefore, miners need to use financial derivatives to hedge and transfer risks.

Options

An option is a contract that gives the holder the right to buy or sell an asset at a fixed price at a certain agreed time in the future. Essentially, an option is a bet contract between the buyer and the seller. Due to the differences in each investor's risk assessment and risk preference for the market, people's intended bets will also be different at different times and prices, resulting in buyers and sellers with different exercise prices in various periods.

The recent surge in Bitcoin seems to have brought excess income to the mining industry, but mining requires fixed costs for mining machines and electricity costs. In addition, it faces increased mining difficulty due to a significant increase in the computing power of the entire network. Therefore, these risks must be taken into comprehensive consideration.

If the price of Bitcoin drops, it will take longer for miners to recover their investment, or if the trend of Bitcoin reverses and enters a downward cycle, miners will face the risk of losses. Therefore, we can use options to lock in risks and maximize profits within controllable risks.

Option Value

The value of an option comes from two aspects, intrinsic value and time value:

1. Intrinsic Value

It refers to the value between the exercise price and the futures price. For example, in a call option, the part of the exercise price that is lower than the futures price is the intrinsic price. If the exercise price is higher than the futures price, its intrinsic value is zero. Similarly, the intrinsic value of a put option is the value when the exercise price is higher than the futures price. If the exercise price is lower than the futures price, its intrinsic value is zero.

2. Time Value

It refers to the remaining value after deducting the intrinsic value of an option from the option price. The time value reflects the time risk within the option trading period. The more volatile the market is, the more expensive its time value will be. That is, when volatility rises, the corresponding option price will be more expensive, and when volatility decreases, the corresponding option price will be cheaper.

Selected Option Strategies

1. Bull market: Bitcoin price is much higher than the shutdown price (aggressive, risk-free leverage)

When miners buy mining machines and start mining, we obtain Bitcoin through the lower-cost primary market. At this time, we have an uncertain payback period for mining, and we can lock in part of the profits by selling call options in the options market.

Since volatility is often greater in a bull market, the price of options is more expensive, so it is more advantageous for us to sell options. In a Bitcoin bull market, the computing power of the entire network is usually higher, and the payback period due to increased mining difficulty will also be longer. If only forward options are sold, the income may be relatively stable, but the disadvantage is that if there is a larger upward trend in the future, Bitcoin will miss the opportunity to make huge profits.

Therefore, in order to protect profits while obtaining the possibility of higher returns, we can choose to sell out-of-the-money call options with a seven-day expiration date, and buy a small number of at-the-money call options at the same time (so that the profit from the out-of-the-money call sell options is equal to the cost of the at-the-money call buy options). After the seven-day expiration and delivery, miners can continue to sell out-of-the-money call options with a seven-day expiration date, and buy a small number of at-the-money call options at the same time, and repeat this process until the Bitcoin price begins to plummet and is less than 20% away from the shutdown price. At this time, they can sell at-the-money call options and buy a large number of out-of-the-money put options at the same time (this way, the profit from selling at-the-money call options can be equal to the cost of buying out-of-the-money put options).

2. Shock: Bitcoin price is much higher than the shutdown price (robust type, subsidizing risk through time value)

In the case of continuous fluctuations in the Bitcoin market, miners can sell 7-day out-of-the-money call options equal to the output of their mining machines, subsidize their income through time value (i.e. bear the risk of volatility), and enjoy the benefits brought by the increase in Bitcoin prices. Similarly, when the Bitcoin price begins to plummet and is less than 20% away from the shutdown price, they can sell at-the-money call options and buy a large number of out-of-the-money put options (which can make the income from selling at-the-money call options equal to the cost of buying out-of-the-money put options).

3. Downside: Bitcoin price is higher than the shutdown price (conservative, lock in profits)
When Bitcoin is in a downward cycle, miners can sell at-the-money call options that expire in 7 days, and buy 7-day in-the-money put options at the same time (so that the profit from selling at-the-money call options is equal to the cost of buying out-of-the-money put options). When the Bitcoin price is lower than the shutdown price, miners can then sell a large number of 7-day out-of-the-money call options (to subsidize electricity bills).