29 Apr CME Group (CME)

Bitcoin has had a crazy ride since it came into existence in 2008. In the short space of a decade, it has made investors both millionaires and paupers depending on when you decided to invest. The volatility of the digital currency has been a major talking point in recent times. In April Bitcoin dropped 20%, and at one point was down 15% in a day. It was its biggest intra-day drop since……… well, February. It does this all the time. In 2017 alone it dropped more than 30% on multiple occasions. Each time though it has bounced back and continued on its upward run.

So why the volatility and can we make money out of it? When we look at investing in a stock there are underlying aspects to that particular company that we can place an actual value on. Its fundamentals, valuation, earnings potential, macro trends, and the list goes on and on. Bitcoin, and all of the other cryptocurrencies, don’t have this luxury. They are traded purely on supply and demand. There is no intrinsic value, there is only what a buyer is willing to pay for it. If the world decides it’s worth nothing then it will be worth nothing. There are no assets to sell, no backing from a government or other entity. It’s simply a matter of how popular the idea is at any particular time.

It’s why I haven’t invested in it and can’t imagine I will anytime soon other than taking a little punt here or there. Anything that can instantly have no value doesn’t really sound like a safe investment to me. Whether it be through a loss of public interest, or regulators clamping down on its use to combat money laundering, I don’t want to be holding it when the bottom falls out. If the bottom falls out. It may not of course, but there’s every chance it will.

But I must admit I love watching the drama. I love seeing it skyrocket, and I love seeing it come crashing down. It’s exciting to follow when you’re only a bystander. I also love the fact that I can make money while watching all of the chaos. It’s where today’s stock report subject comes in. It’s bringing to market a new product this week that’s going to make it easier to profit from all of this volatility.

CME Group is the world’s largest financial derivatives exchange. It successfully runs multiple exchanges including the Chicago Mercantile Exchange, the Chicago Board of Trade, and the New York Mercantile Exchange. On these exchanges, CME offers futures contracts and options trading a variety of different asset classes. Want to trade Currency? Treasury Notes? Gold? Real Estate? Interest rates? Dow or S&P500 Futures? Oil? Copper? Corn? Soybeans? Pork Bellies? Milk? Cheese? Then it’s done through a CME owned exchange.

CME handles upwards of 3 billion contracts worth approximately $1 quadrillion annually. That’s $1,000,000,000,000,000 when written out. It processed 22 million contracts per day in the first three months of 2021. This was its third most active quarter ever. The most active was the first quarter of 2020 when the pandemic took hold and they processed 27 million contracts per day. Of these trades, CME takes a small cut from each transaction. It was enough to give it trading revenue of more than $1 billion in the last quarter.

Investors, money managers, and commercial entities use derivatives to hedge risk and lock in prices for their products. Sellers of a commodity can lock in a price well into the future, and likewise, buyers can do the same. Of course, speculators also use these products to take bets on the market. If you believe that the price of an oil barrel will rise as we come out of global shutdowns you can buy a crude oil contract. Or if you think the price of pork might drop to a glut in the market you can sell a Lean Hog futures contract. It’s a punters paradise.

So how does this all relate to Bitcoin? Well, like everything else CME group has a Bitcoin futures product where investors can buy and sell ownership, or monthly contracts, without having to actually go through the rigmarole of setting up a bitcoin wallet. The contracts are cash-settled which means there is no physical delivery of the product. You just win or lose cash depending on the price.

Currently, the BTC contracts are pretty huge. Each one is for 5 bitcoins and requires a margin of well over $100,000 just to get started. This is fine for the massive hedge funds or big-time punters, but it has left retailers out in the cold. And retail trading is where the bitcoin action really is. Even now, retailers account for the majority of buyers of the BTC bitcoin contracts. Hedge funds are by far the largest net sellers. You can take from that what you will about the future pricing of bitcoin but it’s a fact that there is lots of interest but at a difficult price point.

Hence the introduction by CME of the micro bitcoin contract – MBT. It kicks off on Monday, May 3rd, and instead of holding the value of 5 bitcoins, it holds just 10% of the value of 1. The cost of holding one will drop by a factor of 50. Accounts with no more than $5000 will be able to open a position. The move will open up bitcoin futures to a whole new generation of investors.

Bitcoin futures trading rose by 43% in CME’s last quarter, to an average of 13,545 contracts per day. It’s hard to imagine trading figures not rising exponentially as it becomes more accessible. On its latest conference call CEO Terry Duffy exclaimed “Obviously, the massive increase we’ve seen in the price of the cryptocurrency in and of itself lends to a smaller contract for more participants to manage their risk”. It ties in perfectly with CME’s efforts to attract more retail business.

CME is still trading at the same price you could get back in August of 2019. The pandemic hasn’t been kind to the group. It’s mainly been affected by all-time low interest rates. When rates are near zero there is no interest rate risk for companies. They, therefore, have no need to hedge that risk. Interest rate contracts made up just under half of all contracts for 2019. This was down to just over one third by the end of last year. Revenue was also down by 18% in the last quarter. It’s been a tough haul, but as the US economy improves so will derivatives trading. And CME group will be right there taking advantage. As it will as interest rates eventually rise.

CME’s focus on new products and its moves to attract the retail client will likely prove successful in the future. They have a virtual monopoly on derivatives trading which will be around for centuries (assuming climate change doesn’t get us all first). It’s a proven moneymaker that pays a solid dividend of 1.7% and a special yearly dividend that brings the total yield to 3%. And unlike bitcoin, it has assets in its exchanges that are considered extremely valuable. It’s a great long term hold and one to buy on the dips.