Revisiting BITO And GBTC Before The Coming Bull Market In Bitcoin

Produced by Ryan Wilday with Avi Gilburt and Jason Appel

Grayscale Investments is locked in a battle with the SEC over turning its Bitcoin (BTC-USD) trust, symbol (OTC:GBTC), into a spot ETF. So far, the SEC has rejected Grayscale's filings. They cited that manipulation of the spot Bitcoin market is hard to detect. But the SEC has already approved a Bitcoin futures ETF (NYSEARCA:BITO), which has a NAV directly derived from the same spot market. So Grayscale has taken its fight to the courts.

Converting the fund into an ETF will give Grayscale the ability to keep the share value equal to the net asset value (NAV) of the Bitcoin held in the fund. While the trust used to trade at a premium to the Bitcoin held, it dropped to a recent 49% discount to that Bitcoin. This has made GBTC a poor proxy for Bitcoin exposure.

Grayscale's lawsuit had its first day in court on March 7, 2023. The day is widely held as positive for Grayscale. The judges seemed to question the basis and integrity of the SEC's arguments. A decision is not expected until later this year. However, GBTC traders wasted no time closing the GBTC discount. Between the March 6th close and that of the 7th, GBTC's discount to NAV moved from 42% to 35%.

So, GBTC holders en masse, which includes me, have made a bet that GBTC will be converted. They are sitting on an investment that is a poor proxy for Bitcoin believing in the potential that it gives us an instant 200%+ move to get it back to par.

I don't mind having a small amount of money on this bet, but I want a more reliable proxy for Bitcoin exposure. This is all the more important now that we have the first substantial bullish move in Bitcoin. My colleague, Jason Appel, is planning a more focused Bitcoin update soon. Watch for it. However, I want to quickly discuss what I see as bullish via a technical analysis of Bitcoin.

Bitcoin has broken over its wave 4 resistance in what has been my primary count shown in red. From an Elliott Wave perspective, this opens the door to $125K, a target I have discussed since 2020. But note: Bitcoin will have more to prove as it climbs. This has occurred after breaking my critical support at $16K. But that breach was only made by $500, leaving us with a now very critical level at $15,500.

We have the first substantial higher low in Bitcoin after a sub-30 RSI since the bear market began in 2021. This is a classic technical signal I've used for over 5 years in my Bitcoin trading. So far, it hasn't disappointed me.

So-called "crypto contagion" has resulted in strong crypto moves. When the FTX (FTT-USD) exchange failed in November last year, Bitcoin put in an important low and has almost doubled since. With two key banks - Silvergate (SI) and Signature ("SBNY") - supporting the crypto industry failing, Bitcoin rallied 40%.

BITO Revisited

Now that Bitcoin may be turning bullish, interest in the asset will grow, at a time when most people do not have crypto exchange accounts. That's why I wanted to help readers evaluate how to obtain that exposure in their brokerage accounts. While there are many Bitcoin trust funds, like GBTC, and a few Bitcoin futures-based ETFs, like BITO, those two symbols are the most actively traded in brokerage accounts today.

On 18 February 2022, I wrote an article discussing the trade-offs of BITO vs. GBTC. BITO was very new as a fund.

At that time, the GBTC discount was 24%. As I stated, my concern with GBTC is that the discount continues to grow as there was no mechanism for that to close. Sure enough, that discount doubled at its 52-week extreme since that article was written. Over the last year, I have suggested to my subscribers that GBTC was not a good place for continued exposure beyond short-term trades, and I began to cover BITO actively.

Now that BITO has been on the scene for a little over a year, we can look back at my earlier concerns. In that article, I concluded that BITO was likely a better investment than GBTC, but I will revisit my concerns here.

BITO Concerns

I noted in the article that it would likely decay vs. the value of spot Bitcoin, because it holds futures contracts that are in contango. This decay is called roll decay, as the fund sells upfront contracts and rolls to the next contract at a higher price.

BITO Decay

Based on its then short history, I predicted that the decay could be 9% per year. Now that BITO has been around for over a year, that decay has only been roughly 5%. Further, that decay continues to narrow. In short, this is less of an issue with BITO than I believed earlier.

Over the last year of trading, I also noticed a peculiar benefit in trading BITO. Bitcoin futures tend to wander from contango to a discount versus spot near important lows. While these flips provide me with a secondary buy signal for Bitcoin, it also creates reverse decay for those who buy BITO during those times. It is like buying Bitcoin on a discount, and typically, it snaps back as the market bottoms.

Dividend Bonus

Two months ago, I was pleasantly surprised when I reviewed my retirement account. I noticed a dividend paid on BITO worth ten cents per share. That dividend turns out to be monthly. Upon investigation, it looks like that dividend comes from the treasuries the fund holds, instead of cash. It holds futures fully collateralized, so it isn't a leveraged fund and that collateral pays a dividend. Right now that dividend covers the roll decay in the fund and more. But naturally, as BITO goes up in value and interest rates drop, the yield will be smaller than what the fund currently provides.

Option Income

Lastly, in my above-mentioned article, I discussed the potential of selling options on BITO to fight decay. I have deployed that strategy over the last year. My first entry in my retirement account involved selling a January 2023 $20 put. I was assigned the shares at expiration while BITO was at $15, so I was underwater.

However, since then, I have sold options, both calls and puts. My shares have doubled in quantity, and my cost has dropped to $13.72 per share. As of writing, BITO's last close was at $16.42.

Naturally, doing outstandingly well with this strategy requires some skill in market timing and options trading. Regardless, provided you sell cash-covered puts and don't use margin, these trades are risk-reducing. However, while I have benefitted from the strategy, it was unnecessary to fight roll decay. That was the original intent, but roll decay is much lower than expected.

BITO Technical Analysis

I have fought an issue with doing Elliott Wave analysis for BITO. It is 99% correlated to Bitcoin but is missing Bitcoin's 24/7 price action. Key highs and lows that are critical to a solid count can end up after stock market hours, so are missing on the BITO chart. To manage this issue, I created what I call my BITO synthetic chart. It's basically a Bitcoin chart with a multiplier used to achieve a rough BITO value with the full hypothetical 24/7 range. It doesn't work for determining support to the penny, but it is solid for swing trading and long-term projections.

The bottom line is that if Bitcoin is headed to $125K, BITO should reach $80, which is roughly five times today's value. I am not going to give you a time frame for that projection as my work is not time-based. However, this is my expectation in the future.

Zoomed in, we may have circle-1 of a third wave in place. Support for circle-2 is in the $13.50 region. If that level breaks, all is not lost. However, Bitcoin will break into that larger degree wave-ii on my chart below. Support for that wave-ii is $10.80. That level is critical. If BITO sustains below that, it likely comes with Bitcoin threatening a break of that very critical low at $15,500 in November of last year.

Wrapping It Up

In conclusion, we have some bullish indications from Bitcoin, and it may be starting a new bullish cycle. I wanted to write this article for those who do not trade spot crypto but would like to have some exposure in their brokerage accounts. Over the last year, I have been both a trader and investor in the Grayscale Bitcoin Trust and the ProShares Bitcoin Strategy Fund. My conclusion is that BITO is the best choice for investors:

1. The futures roll and its resultant decay in the fund have been minimal: 5% over the last year and declining.

2. Currently, BITO pays an outsized dividend for such a fund while interest rates are elevated. That dividend is temporarily high but available in the short term.

3. GBTC's discount is a risk that investors cannot control. It may reduce - or worsen - but, importantly, it has not been predictable.

Finally, do recognize the risk of futures ETFs. We've seen some blow up, like the failure of the short volatility fund XIV in 2018. That was an event now called "Volmageddon." The Bitcoin futures ETFs don't have the same level of risk that a short-vol fund has, but the risk of futures ETFs should be noted.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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