By Darrell Martin
If a circuit breaker in a building is tripped, the part of the building serviced by that circuit’s power goes out. It is halted. In trading, if the market drops too quickly, it also trips a circuit breaker, which halts trading for 15 minutes. There are predefined levels based on the S&P indicating the market wide circuit breakers. Should the market continue to drop, trading would again be halted.
Level one is when the index falls to 7 percent below its previous close. Level two is a 13 percent drop, with level three being a 20 percent drop. Levels one and two halt trading for 15 minutes, unless it occurs after 3:25 pm. If that happens, trading is allowed to continue since it is near the end of the trading day. No matter what time a level three occurs, it will halt trading for the remainder of the trading day (9:30 am - 4:00 pm ET). These circuit breakers have been in place since February 2013, with others set up before that time.
Single stocks have their own set of circuit breakers, which halt the market with up or down moves outside of certain bands, for five minutes. Circuit breakers are designed to curb panic selling on US stock exchanges, which could lead to excessive volatility.
This all makes sense and seems to protect the traders and investors until you apply it to trading Bitcoin. The CME (Chicago Mercantile Exchange) will launch Bitcoin Futures (BTC) on December 18, 2017. However, options are not planned to be released for a while due to high Implied Volatility. To begin with, it would be hard to price them.
Each Bitcoin contract will contain five bitcoin at a value of five per tick, making a single tick valued at $25. However, they also stated they are most likely going to launch a mini contract. Since each full contract is made up of five bitcoin, it can’t be divided in half without making numbers complex. Chances are that the mini contract might be a single bitcoin future with a value of $5 per tick.
Since it is listed as an equity index, it will probably trip the price limit circuit breakers often. If that is the case, those rules may have to be quickly changed. The danger is being stuck in lock limit where the market trips every breaker and then shuts down only to reopen to instantly trip the breakers day after day. If this happens, there will be no options, hedging or exercising to exit.
Nadex announced on December 7, they would begin offering Bitcoin Spreads at 6pm ET Sunday, December 17. Trading Bitcoin Spreads on Nadex will allow retail traders the opportunity to take short-term positions with capped risk and reward built in. The Bitcoin Spread’s value will vary within the floor to ceiling range as the price of Bitcoin moves up and down. As with all Nadex Spreads, traders are protected from losses above the ceiling and below the floor. Profits occur from price action within the defined floor-to-ceiling range.
“We saw a strong desire from individual traders to access cryptocurrency markets in a way that makes sense for them,” said Nadex CEO, Timothy McDermott. “The Bitcoin market offers great trading opportunities, but these opportunities come with significant volatility. Our Bitcoin Spreads let traders take short-term positions in this new market without the same large or unlimited risk exposure found in other markets.”
At this time, with the absolutely insane volatility of the market, Nadex will only be listing one weekly Bitcoin Spread to start. The contract will be one-tenth (1/10) the per point value of the underlying. Therefore, a 10,000-point floor-to-ceiling range will have a total value of $1000. Since there is no telling how far and how fast this can go, Nadex will list additional spreads as needed.
As Nadex announced the upcoming Bitcoin Spread contracts, as of December 7, Demo contracts are already available under Cryptocurrency in the Nadex finder, giving traders a chance to experiment with trading Bitcoin Spreads before going live.
As you can see in the above image, each spread will be 10,000 points wide. They will be worth 10 cents a tick, with expiration occurring at 3pm ET on Fridays.
Nadex’s Bitcoin Spread’s underlying price will be derived from the TeraBit Index, which has been published by TeraExchange since 2014. This data comes from 10 underlying bitcoin spot exchanges. The TeraBit Exchange was created to meet the CFTC requirements.
Being able to trade Bitcoin Spreads on Nadex will make it possible for individual retail traders to trade this popular, yet volatile asset with defined risk and affordable capital requirements.
Bitcoin futures can have massive daily moves, blowing the circuit breakers causing traders to be stuck in their trades to the tune of losing-more-than what’s-in their-accounts. If this happens often enough, BTC might be reclassified as a Forex contract. Essentially, it is BTC/USD showing Bitcoin priced in US dollars. FX has much larger breakers with the final breaker having no limit. Each FX pair has its own limits, which can be made extremely large.
It will be interesting to see how the launch of Bitcoin plays out with the circuit breakers set where they are currently. For more information on the launch of bitcoin, see Bitcoin Futures Contract Specs. To learn more about CME’s circuit breakers, click here. Visit Nadex for more information about the upcoming Bitcoin Spread release.
Apex Investing offers free trading education at apexinvesting.com.