BITO: Simple And Easy Bitcoin Price Exposure

Summary The ProShares Bitcoin Strategy ETF utilizes front-month CME futures contracts for investment exposure to the price of Bitcoin. The fund has generally lagged the performance of the underlying asset and a competing BTC futures fund from VanEck. NAV arbitrage isn't a concern to the degree that it has been in GBTC, so the fund will likely work fine as a simple BTC derivative bet. On October 16th, crypto news outlet Cointelegraph inaccurately reported via Twitter that BlackRock's ( BLK ) spot Bitcoin ( BTC-USD ) ETF had been approved by the U.S. Securities and Exchange Commission. The initial reaction to that incorrect reporting sent BTC roughly 8% higher in about an hour. The surge quickly reversed when the report was dismissed as incorrect. Importantly, this news came just a few days after the SEC's deadline to appeal the result of the Grayscale lawsuit passed without an appeal . It's looking increasingly likely that there will be a spot Bitcoin ETF approval in the near future with some even expecting one before the end of the year. The arrival of a spot ETF could be a major development for a community that to this point has seen most of the investment demand for BTC flow to the Grayscale Bitcoin Trust ( OTC:GBTC ) and the ProShares Bitcoin Strategy ETF ( BITO ). Each of these funds has limitations that have left many hopeful for a spot ETF. I've covered Grayscale's Bitcoin Trust numerous times for Seeking Alpha, so I don't want to spend a lot of time in this article on that fund. I'm personally bullish on GBTC because the fund has traded at such a steep discount to net asset value and I see that discount as a phenomenal arbitrage opportunity even if the underlying asset doesn't move all that much between now and the end of the year. So far that trade is working out very well, and it has allowed GBTC to outperform both Bitcoin and BITO year to date: Data by YCharts However, in this article I'd like to explore BITO a bit more and get into why I think there are alternatives that investors may want to consider. Futures vs. Spot One of the key differences between BITO and a potential spot ETF is that the ProShares Bitcoin Strategy fund utilizes CME Bitcoin futures contracts rather than holding the underlying asset either directly or through a custodian. Since the futures contracts are cash-settled, the issuer never actually holds any BTC in the fund. This is different from a spot ETF which could hold a certain amount of Bitcoin per share outstanding and allow for asset redemptions to mitigate the kind of NAV issue that we've witnessed in GBTC shares over the last couple of years. BITO Holdings (ProShares) ProShares generally stick to front-month futures and have exposure to the October and November CME contracts currently. It's important to note that futures work differently than options. With options, there is no obligation for the speculator to exercise. With futures contracts, the speculator either needs to take delivery of the underlying asset or roll over the contract to a later maturity date. ProShares is doing the latter with BITO and that creates a scenario where contract rollover costs could hinder the performance of the fund compared to alternatives. This is something ProShares addressed in its one-year review last October and made note of how much rollover costs have come down since inception. BITO Prospectus (ProShares) The roll-over costs have also been partially offset by the yield from treasuries that ProShares holds in the fund. And this brings us to BITO's massive dividend yield. But That Dividend Though In an effort to avoid paying excise taxes, ProShares distributes taxable income from gains on its futures positions to BITO shareholders. This means that the dividend can fluctuate significantly from month to month, and we've seen that already in BITO's distributions this year: BITO Distributions (Seeking Alpha) The July dividend was $0.66 while the October dividend was just $0.07 and the September dividend was less than a penny. However, these dividends do dramatically impact the total return from holding BITO compared to simply looking at the share price: Data by YCharts Still, even when accounting for distributions the total return from holding BITO shares is 700 bps below the return of the underlying asset year to date. BITO vs. XBTF The question for potential BITO buyers is does a better alternative exist? Buying and holding Bitcoin directly makes the most sense for anyone who wants to minimize fees and fund decay, but buying directly exposes investors to capital gains taxes. There are ways around that as well, but not everyone is willing to open up a crypto IRA through a platform like iTrustCapital or Choice. For typical investors who want simple Bitcoin exposure in a tax-advantaged investment account, BITO isn't a bad option as it has less NAV arbitrage variance than funds like GBTC or Osprey Bitcoin Trust ( OTCPK:OBTC ). But compared to something like the VanEck Bitcoin Strategy ETF ( XBTF ), BITO's performance is a bit more mixed: BITO XBTF AUM $893m $46.5 Expense Ratio 0.95% 0.76% Dividend Frequency Monthly Annual Yield TTM 18.69% 0.25% YTD Total Return 63.0% 63.4% Source: Seeking Alpha From a total return standpoint, BITO is trailing XBTF year to date by about 40 bps. Over the last 12 months, the head-to-head performance is actually a bit worse for BITO: Data by YCharts There we see XBTF ahead by 300 bps. And it's worth repeating that each of these funds is underperforming the underlying asset. In addition to the lower expense ratio and the very different dividend schedule, VanEck's Bitcoin Strategy ETF currently only has exposure to the October contract while BITO has both October and November with a larger weighting to October. This maturity strategy may be contributing to the discrepancy in the fund's performance versus XBTF. Risks There is risk when investing in Bitcoin, crypto, and derivatives. While I'm very bullish on BTC personally, there is no certainty that the coin's price post-halving will behave the same way it has in the past. Bitcoin has gone through many booms and bust cycles, but crypto has never faced a 5% fed funds or short-duration T-bills that pay nearly 6% before. While I'm of the view that we will soon have far more regulatory clarity for the crypto industry in the United States, the reality is we still don't know for sure what the SEC is going to do with the spot ETF applications. But in the event those applications are approved, spot ETFs will ultimately compete with BITO and likely track the return of BTC better since there won't be rollover costs. Summary If you're looking to tactically trade Bitcoin in a traditional IRA, BITO will help you do that. I personally like GBTC better given the arbitrage opportunity from the NAV discount. But until there is a low-cost spot ETF in the US market, there are worse ways to get BTC exposure in a tax-advantaged account. BITO has better liquidity than XBTF and has a total return that appears to be tracking peers better this year than it has in the past. I don't hold BITO personally, but I think Bitcoin will be higher in the next 12 months, so I'm rating the fund a buy regardless.