Is There a Relation Between Futures Expiration Day and the Market Dump?
Trading Analysis

Is There a Relation Between Futures Expiration Day and the Market Dump?

Created 1yr ago, last updated 1yr ago

The entire 2021 has seen major market dumps right before the expirations of CME Bitcoin futures. Will the history repeat itself? Read more!

Is There a Relation Between Futures Expiration Day and the Market Dump?

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A simple question must beget a simple answer. Does the expiry of futures contracts on the popular futures exchange like CME impact the price of Bitcoin?

Yes! Historically, it has been proven that prior to the date of the settlement of the contract, there is an observed 2% drop for both median and average. While this dramatic price fall is largely credited to large institutional-sized investors who sell/buy Bitcoin at this time, the story goes deeper than that.

In this article, we will explore the kind of impact that contract settlement dates have on Bitcoin's price at a broader level. Let's dive in.

When Are Bitcoin Futures Settled?

For the purpose of this article, we will be looking at the Chicago Mercantile Exchange (CME), one of the first exchanges to offer a futures contract on Bitcoin. It has the largest volume of futures contracts traded. On the exchange, each contract comprises five Bitcoins and the maximum position is set at 4,000 contracts (or 20,000 Bitcoins). The futures contracts on the exchange are settled on the Friday of each month at 4 PM London time. Since these are derivative contracts, the contracts are cash-settled.

What Is Rolling Over of Futures Contracts?

A crucial point to understand here is the rolling over of futures contracts. This is done when traders want to hold on to their futures contracts even when it is expiring. To achieve this, they generally sell their old contract and buy a new one at the then-market price of the contract. This helps them sustain their position.

With Bitcoin, however, traders have the option to get a perpetual futures contract that never expires. This ensures that their positions are opened even the traditional futures contract holders might need to close theirs.

It is this rolling over that also impacts the price of Bitcoin when the futures contracts are settled.

Futures Contract Settlement and Their Impact on the Underlying Asset

This is a heavily researched topic in traditional financial literature, with several reports already being compiled that show how the underlying asset's stock price does get affected in such instances. A report compiled on the intraday analysis of assets traded on the Warsaw Stock Exchange revealed a very clear indication of how the volume of turnover of profits would suddenly shoot up on days of the expiration of the futures contracts.
It is relatively easy to understand this phenomenon in the traditional financial markets because of the volume of institutional (or bigger-sized) investors who are participating. For the crypto markets, too, the institutional investors (who are known as "whales" in the industry) can adopt various ways to influence the price of Bitcoin on settlement dates.
  • The first possible strategy is to buy both physical Bitcoin and sell the futures contracts on the asset. This helps them stay profitable if any one of their position plays out against them. For instance, if the price of Bitcoin increases then they can close their long position and make a profit. On the contrary, if the price reduces then they can simply short their position and remain in profit even though their long is unprofitable.
  • Another possible strategy is to acquire physical Bitcoins and sell them prior to the settlement date, inducing a price drop. If this is done strategically, then they can also short their futures contracts accruing a profit. For this to happen, however, the investor will have to have a significant position in the market and will have to perform their trade on one of the exchanges that are being tracked for futures price settlement.

Since Bitcoin is settled in USD and not in BTC, it is quite easy for traders to manipulate their futures position to their favor.

While it is hard to look at the blockchain and review the contract where the money comes from and where it goes to, because all of it is happening via contract addresses, it is hard to pinpoint the investor who ends up manipulating the price. Regardless, it is something that does happen and has been proven in the past. In fact, the trading volume of the underlying asset often sees a rise as we near the settlement date for the contracts.

In an analysis conducted by Arcane Crypto for the average return on Bitcoin between Jan 2018 and Aug 2019, it was found that before the CME futures contract settlement date, there was a negative return of 2.2% on Bitcoin.

In fact, their data revealed that out of the 608 days they analyzed, they found that for almost half that duration, the price was average a positive return. Thus, the average return was roughly 50% positive and 50% negative. However, as the report said, right before the settlement "something completely different" was seen in the returns on the asset. About 75% of this time, the returns were said to be negative.

If you're thinking that this data is quite old and things might have changed since then, think again. The entire 2021 has seen negative returns on the price of Bitcoin especially on (or just a day before) the close of CME BTC futures. Let's have a look at what happened on January 29 of this year.

That was the day of the settlement of Bitcoin futures contract. While the price largely remained level, there was a sharp increase in the trading volume on the day, which suddenly fell down immediately after.

While it is hard to comment on whether there is a sharp drop in the prices of Bitcoin on the days of the futures settlement, there are signs that indicate there is significant movement in the markets on that day. Some have called this "daylight manipulation". While it is too harsh a term for something we can never be completely sure of, it is certainly something that traders can be wary of.

Now, with the launch of an entirely new Bitcoin futures ETF (BITO), there has been a surging interest in the derivatives market for cryptocurrency.

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