Current Price: $33.75
Target Price: $41.87
Expiration Date: Nov’21
This is a crypto-related idea. The setup is interesting and there is an easy way to hedge crypto volatility risk. Over the last few days, the discount has started to narrow, so the idea might be timely.
Grayscale Digital Large Cap Fund is a physical (not futures-based) crypto investment fund that trades OTC with a ticker GDLC. 65% of fund assets are in Bitcoin, 25% in Ethereum, and the remaining 5% in other coins. Historically the fund has mostly traded above the NAV, with the premium spiking to 100% at one point (end of Aug). However, over the last couple of weeks the fund started trading at a discount to its NAV. Current spread stands around 25%. The trade here is to buy GDLC and hedge Bitcoin and Ethereum exposure by shorting perpetual futures (available through FTX.com). At the moment hedging does not cost anything – actually arbitrageurs are getting paid on short BTC and ETH positions.
Full portfolio documentation can be found here.
Historical chart of GDLC unit market price and NAV (Grey – price. Green – NAV).
As can be seen from the chart over the last couple of weeks, most likely due to the sharp crypto market appreciation, a pretty large discount to NAV has appeared, offering an interesting trade on the discount elimination or even spread reversal to premium in line with historical precedents.
Historical premium pricing is likely explained by investors’ willingness to have exposure to crypto and limited possibilities to invest in crypto directly.
Hedging could be done through crypto or crypto ETFs.
The cheapest and cleanest way to hedge exposure to Bitcoin and Ethereum seems to be through FTX markets offered BTC-PERP and ETH-PERP futures. FTX account setup is quick and painless. The important thing to note here are the funding fees. These are similar to borrow fees, but settled hourly. The charts below depict historical funding fees for the 30-day short position holding period. The funding rate is driven by the difference between the future price and the spot index. If the funding rate is positive (meaning that futures are more expensive than the index), investors are actually getting paid to hold a short position. If the funding rate is negative, shorts are paying longs. So far this year, it seems that the funding rate has been positive almost all the time (currently positive as well), so in fact, arbitrageurs are getting paid to hold the hedged position today.
Another, and probably a simpler way to hedge is through the recently launched Proshares Bitcoin ETF, ticker BITO. The EFT is based on short-term Bitcoin CME futures. Plenty of borrow seems to be available at 4% annually. This would hedge Bitcoin exposure only, but as most of the crypto tends to fluctuate in line with Bitcoin, hedging through BITO might be sufficient to offset most of GDLC NAV volatility.
The launch of BITO might also be the reason why GDLC started trading at the discount – now there is a better alternative to get crypto exposure through traditional equity markets. However, the fund started trading at a discount last week, whereas BITO was launched only two days ago. Also most of the GDLC holders are likely less knowledgeable retail investors, who are unlikely to care that much about the differences between GDLC and BITO. Thus, I doubt that the launch of BITO was the cause for the discount.
- Discount to NAV might persist for longer or never get eliminated at all. It is not clear why it appeared in the first place or what market forces/events are required to close the gap to NAV or for the fund to start trading at a premium to its NAV.
- The fund charges 2.5% asset management fees which sounds quite excessive for passive investment vehicles (although not excessive by crypto return standards). Given these fees, a certain discount to NAV is clearly deserved and in the longer term GDLC would be expected to trade at a discount to its portfolio value.
- There is a risk of hedging cost going up substantially. Over the last year that has not happened, but if crypto enters a sharp bear market and futures start to trade materially below the spot index, hedging costs will spike up.