Options and leverage, a case study

A year and some days ago, my PR was doing her best to explain complicated finance topics on the Bitcoin forum. Of interest is a mention in passing of leveraged BTC fx trading via options,

If you figure in USD, your original investment of 49.64 USD (10.38589110 * 4.78) turned into 250 USD (33.3333333 * 7.5), and thus you've transformed a 50% increase in the price of the underlying into a 500% increase in your dollar position (or 300% if you account in BTC, because the BTC itself increased by 50%). So in this case long CALL contracts allow you access to a 10x leverage factor.

That is all nice and good in theory, but since March was a big monthⁱ it would perhaps provide an interesting study in how that theory works out in practice. So, let's dig into the actual numbers.

As the published results detail, there were 166`125 CALL contracts bought by users from the MPOE bot. In total, these have cost said users 33`082.43287675 BTC. Armed with this information we can compute notional leverage : 166125÷33082.43287675 = 5.021547255, which means that on average users benefited from about 5x leverage, or that for the price of one Bitcoin they got to control the price increase benefits accruing to five Bitcoins.ⁱⁱ

So that's it. People were able to trade 160k worth of Bitcoins on 5x leverage in March. Add to that the various advantages of options, such as :

• No forced liquidations. You've bought your option, it's yours no matter where the price goes.
• None of the usual bucketshop nonsense. Consider the older discussion of icbit.se or this more recent quote :

  MJR_III bitfinex sucks, they don't actually send orders out, but whatever engine they have doesn't send them out quickly enough, which partially gox's fault. it traded down to 87 without me getting filled.

• Much better volatility targetting. PUTs and CALLs mesh together to allow you to target volatility in ways that simply aren't accessible with simple forex tools.

In conclusion : market depth + better instruments = supremacy. That's about all there is to it.

1. The 482`472 contracts traded in March are a significant 38% chunk of the total 1`251`088 contracts traded in MPEx' history (MPOE is older than that, but the August 2011 - April 2012 interval didn't see that much trade - at least not by current day standards). [↩]
2. This is exactly how CALLs work, if you hold one contract you get every dollar that one Bitcoin appreciates past the strike. [↩]