How to Trade the CME GAP for Bitcoin Futures

  • Although CME’s bitcoin futures trading products do not deal in actual bitcoin, they indirectly affect the open market price.
  • Although cash-settled futures are primarily used by institutional investors, retail investors can trade the “CME gap”.
  • If the price of BTC on exchanges is higher than the CME closing price from the previous Friday, BTC’s price usually decreases in order to meet the CME price. If the price is lower than the previous Friday's CME close, then the price of BTC is expected to rise.
  • However, historically, funds that just held bitcoin for the long-term, outperformed funds that engaged in discretionary longing and shorting strategies. So, investors that just want to hold bitcoin instead of trading the CME Gap should not feel like they are missing out.
  • Trading the CME gap has historically worked better in bear and sideways market trends instead of bull markets.

The Chicago Mercantile Exchange Bitcoin Futures Markets can be an opportunity to time the market using contract expirations which generally come at the end of the month. These expirations, over the past year, have had significant correlations with bitcoin’s price movements. This report is on the Chicago Mercantile Exchange (CME) and how traders use financial instruments like futures contracts and shorting to increase their return on investment.

Brief Introduction to the CME

The world's largest financial derivatives exchange, the CME, started offering futures contracts for BTC in late 2017. The futures market is essentially an auction market where parties buy and sell contracts on commodities for delivery on future dates. These contracts are exchange-traded derivatives that cement the future transfer of a commodity at a price agreed upon today. Global trading for most commodities does not produce the unique situation that bitcoin creates. That is, namely, that bitcoin trading does not stop or start at any given time period. It trades all day, every day, and is not tied to centralised time zones and exchanges…at least in theory.

Crypto YouTubers like BitBoy often refer to the “CME gap” but what does the CME gap mean? Unlike Bitcoin, the CME does not trade 24 hours a day. The gap is the difference between the trading price of a CME bitcoin futures contract when the market closes on Friday and opens on Sunday. The gap occurs because there are no trades between the closing period on Friday and the opening on Sunday. The gap can also occur during holidays when the CME is closed.

It’s important to note that the gap does not need to be filled completely. There are CME gaps from 2020 and early 2021 in the $8,000 to $24,000 range that are likely to be unfilled moving forward.

The CME futures market's last trade of the week is at 5:45 PM Eastern Standard Time (EST) on Friday (or 10:45 PM London). Weekends are a perfect example of the CME gap trend. The price of BTC when the CME closes on Friday can be higher or lower than the spot price of Bitcoin on open exchanges like Coinbase or Uniswap. The CME trading hours start back up on Sunday at 6:00 PM EST (11:00 PM London). If the price of BTC on exchanges is higher than the CME closing price from the previous Friday, BTC’s price usually decreases in order to meet the CME price. If the price is lower than the previous Friday's CME close, then the price of BTC is expected to rise. It is less likely, but still, a trend has existed over the past four years. It is easier to drop the price of a commodity than it is to increase it because an increase normally takes more trading volume in order to influence other market participants.

Consensus Effect: What Worked Before May Not Work Again

CME futures contracts usually expire on the last Friday of every month. There has been a long-standing claim in crypto that up to two days prior to these expirations, there is a drop in the price of BTC and then a return to upwards momentum. This pattern does not always hold up, and it is likely due to a phenomenon in macroeconomic markets: the consensus effect. As a pattern is revealed to more market participants, the impact of the cause gets diminished as traders front-run each other days leading up to the event. The result is that the market expects one reaction only to see the opposite.

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For example, if the price of bitcoin went up on weekends and down every Monday morning for four weeks, the market would pick up on this trend, and a trader would buy Bitcoin before the weekend began and sell the Bitcoin on Sunday. However, another trader, anticipating all of the other traders will buy on Thursday and sell on Saturday. And so forth and so on, until the pattern is gone. This does not mean that the market could not go back into a cycle of “weekend pumps and Monday dumps,” just that the consensus effect means the majority of market participants would have to not trade that pattern in order for it to remain in place. In crypto, perhaps more than any other market, it is easy for retailers to have short memories and for institutions to be too fast to fall into their traditional finance and asset trading mindsets, allowing for the consensus effect to be just as fickle and fluctuating as digital asset prices.

As you can see from Figure 2 above, November 2020, February, March, April, May, June, July, August, and September 2021 show a pattern of dipping on or just before the date of the expiration and rebounding shortly after. This is not always the case, as the chart also shows.

A strategy that can be adopted, with the consensus phenomenon in mind, is to take advantage of the statistical potential that BTC expiration dates signal a drop in the overall price of BTC just preceding a CME bitcoin expiration and that the price is likely to rebound after. This is more likely to be a winning strategy in times of sideways market movements, as was the case from May through July of 2021. The old saying “the trend is your friend until the end” is relevant to all asset classes, especially assets in price discovery like bitcoin. This can have potentially devastating impacts in a downward trending bear market, as the instrument to try and capitalise on the overall trend is shorting, which brings up its own inherent risks. With an asset in price discovery, market adoption and impacted by macroeconomic forces like monetary inflation, interest rates and governmental regulations, “the end” part of that old saying above can come at any time. Longing for a higher price later on at least leaves one with the underlying asset, but no other obligation than tying up capital waiting for prices to at least rebound to purchased levels.

A report by PwC on cryptocurrency trading strategies by hedge funds, family offices, and high-net-worth individuals showed that just holding bitcoin for the long-term outperformed more complicated strategies. The report broke down the strategies into four main categories including quantitative, discretionary long-only, discretionary long/short or multi-strategy. The long-only strategy of “hodling” bitcoin outperformed other strategies during bull runs (2019 and 2020). Not to mention the taxes associated with frequently trading cryptocurrencies. Therefore, investors that just want to hold bitcoin instead of trading the CME Gap should not feel like they are missing out.

Four Basic Strategies for Trading the CME Gap

Without investing directly in CME futures contracts, there are ways to play the CME gap or contract expirations under the correct market conditions. The first two deal directly with the underlying asset. The last two have increased complexity but are extensions of using the same market insights.

  1. The first of which comprises buying the underlying asset directly and longing the position. This would mean timing the asset at a lower dollar price and selling the amount after the price rises. In relation to our CME price, buying the dip just before a contract expiration and selling it once the price increases. One of the benefits of this strategy is that it simply relies on the investor seeing this dip and buying it while it is happening rather than speculating if it comes. The CME expirations are no surprise, so any investor who is paying attention, the 48 hours prior to their expiration, may move into a position and sell the position if the price rebounds. The worst-case: the investor is left holding the underlying asset longer than they may wish if the price does not rebound.

  2. The second consists of “shorting,” which assumes taking the position prior to the price dipping. Holding the underlying asset, someone sells an amount of BTC at a higher price and waits for the CME dip to occur. Then the investor buys back in with the amount of money they sold their original position for and ends up with more BTC than they did previously. The worst-case: the investor has to buy back into the investment with less BTC than they had previously if the price moves north.

  3. Third, a trader can use different exchange platforms to trade their position using leveraged or margin trading. For longing, the trader is putting up collateral to borrow money used to purchase a larger position in bitcoin at the current price, which they then will sell for a profit if the price increases. If the price drops, they can be liquidated (left with a balance of zero in their position) of their collateral.

  4. Fourth, using the exchange platform to trade on margin, but this time to short. This requires borrowing bitcoin at the current price, selling them, and returning the loaned bitcoin later, with the expectation the price is going to drop. Using margin to short can be beneficial, as you do not have to sell your own BTC, and the trader can still capitalise on a decline in the price of bitcoin. There are several different exchanges like Bybit, Prime XBT, Phemex, and FTX, which can help a trader engage in longing and shorting with leverage.

Conclusion
During a bear market or periods of sideways movement for Bitcoin, trading the CME gap may help traders increase their positions over time. However, investors have to make sure to take into account other macroeconomic factors, including the central bank’s interest rate policy, or this potential pattern can cause an expensive trap. Investors that try to short bitcoin in anticipation of the spot price converging or meeting a lower closing price of bitcoin futures on the CME might get caught out if bitcoin continues to rally instead of filling the gap.

*Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial,