Short Microstrategy (MSTR) & Long Bitcoin (BTC): Arbitrage Strategy for Traders

Given the strong historical correlation between MSTR & BTC, and the premium of MSTR... it could make sense to short MSTR & long BTC for some traders

It is widely known that MicroStrategy (MSTR), led by the GOAT Bitcoin (BTC) stan Michael Saylor, commonly sells MSTR shares with a BTC premium relative to spot BTC.

Right now (Dec 2024), buyers of MSTR shares are paying a ~2.27x premium for Bitcoin.

With BTC trading at $100,000, MSTR’s implied BTC valuation is $227,000 per Bitcoin—more than double (2.27x) the spot price.

This inflated valuation has led many to believe that such a steep BTC premium for MSTR is unsustainable and will likely contract as the market becomes more rational.

Historical price movements show a 1:1 correlation between MSTR and BTC, further reinforcing the expectation that MSTR’s premium will eventually align more closely with Bitcoin’s actual market value over time.

Building on this thesis, traders have proposed a “short MSTR, long BTC” arbitrage strategy, which involves:

1. Shorting MSTR to capitalize on a decline in its premium.

2. Longing BTC to hedge against Bitcoin’s price movements.

The strategy is delta-neutral, meaning profits come from the narrowing of MSTR’s premium (i.e., its inflated BTC valuation converging toward spot BTC) rather than from directional changes in Bitcoin’s price.

This approach ensures that any contraction in MSTR’s premium yields a profitable outcome.

While the strategy can be effective, it comes with notable risks, including:

• Correlation breakdowns: Deviations in the historically strong MSTR-BTC correlation.

• Market sentiment shifts: Changes in speculative enthusiasm could sustain the premium longer than expected.

• Costs and liquidity constraints: High borrowing fees or illiquid markets could erode profits.

Note #1: While this strategy can work, it’s not something most people should be trying. It carries a lot of risk and requires a lot of planning, thinking, management, etc.

Note #2: If you actually believe in crypto, it’s much easier to simply buy BTC during a bear market or continue averaging in over a long-term. If you have conviction in BTC – then these types of strategies waste time and cognitive horsepower that could’ve been allocated elsewhere.

Short MSTR & Buy BTC Strategy (Overview)

Core idea: The strategy involves shorting MicroStrategy (MSTR) stock while simultaneously longing Bitcoin (BTC).

The goal is to profit from MSTR’s inflated BTC valuation, which is expected to move closer to Bitcoin’s actual market price over time.

By keeping the strategy delta-neutral—avoiding gains or losses from changes in BTC’s overall price—you focus on earning profits as the gap (or premium) between MSTR’s implied BTC value and actual BTC price shrinks.

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Rationale:

1. MSTR as a Bitcoin Proxy: MicroStrategy holds a large amount of Bitcoin and is often treated by investors as a “Bitcoin stock.” This means its price tends to rise and fall alongside BTC, but with a twist—it often trades at a premium.

2. Premium Inefficiencies: In speculative or inefficient markets, MSTR’s stock price can imply a much higher Bitcoin value than the actual market price of BTC. For example, MSTR’s market cap might suggest that its Bitcoin holdings are worth $200,000 per Bitcoin, even though BTC is trading at $100,000.

3. Market Maturity: As the cryptocurrency market grows more efficient—through tools like spot Bitcoin ETFs and better trading options—this premium is expected to shrink. A well-executed short MSTR/long BTC position can profit from this correction in valuation.

Key Objectives:

• Capture the Premium: Make a profit if the inflated Bitcoin value implied by MSTR’s stock price (the premium) shrinks, regardless of whether Bitcoin’s price goes up, down, or stays the same.

• Delta-Neutrality: Protect against gains or losses from Bitcoin’s price changes by balancing the short MSTR and long BTC positions. This way, profit depends only on MSTR’s premium shrinking, not on Bitcoin’s overall price direction.

• Manage Risk: Use correlation (how closely MSTR and BTC prices move together) and beta (how much MSTR’s price moves relative to BTC) to adjust your positions and manage risk.

How the “Short MSTR Long BTC” Strategy Profits

The short MSTR, long BTC strategy is designed to capitalize on the contraction of MSTR's premium relative to BTC, regardless of Bitcoin's directional movement.

1. Bitcoin drops slightly, but MSTR drops significantly

• If Bitcoin declines by a small percentage, MSTR’s price is likely to decline more due to its premium contracting.

• Your short position in MSTR generates a profit larger than any loss on your long BTC position.

2. Bitcoin rises slightly, MSTR drops

• If Bitcoin increases but MSTR drops (perhaps due to premium contraction or reduced speculative enthusiasm for MSTR), your long BTC position generates gains, and your short MSTR position also profits.

3. Bitcoin stays flat, MSTR’s premium contracts

• Even if Bitcoin’s price remains stable, MSTR’s premium contraction alone can lead to profits from your short MSTR position, while the long BTC acts as a hedge.

4. Bitcoin rises sharply, MSTR doesn’t rise as much

• If Bitcoin rallies but MSTR underperforms relative to BTC (due to premium contraction), your long BTC gains more than the losses on your short MSTR.

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Requirements & Assumptions (Short MSTR, Long BTC)

The success of the short MSTR, long BTC strategy relies on several key assumptions about market behavior and relationships between assets.

1. Strong Correlation (~1:1): Historically, MSTR and BTC prices have moved closely together with a near 1:1 correlation. This assumption is critical for the strategy because it ensures that the hedge (short MSTR, long BTC) works effectively.

2. Unsustainable Premium: MSTR currently trades at a 2.27x premium over the intrinsic value of its BTC holdings. This elevated premium is assumed to be unsustainable in the long run and expected to decline as the market matures and inefficiencies are corrected.

3. Efficient Markets: The expectation is that market conditions, such as the introduction of direct BTC investment options (e.g., spot ETFs), will reduce the need for investors to pay such premiums for indirect BTC exposure through MSTR. These developments are anticipated to normalize MSTR’s valuation.

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Risks & Challenges: Short MSTR, Long BTC

While the short MSTR, long BTC strategy offers potential for significant returns, it is not without risks. Traders must be aware of the following challenges:

1. Persistent Premium

   • The premium on MSTR could remain high for an extended period or even expand further.

   • This could occur due to speculative investor behavior, ongoing enthusiasm for MSTR as a Bitcoin proxy, or delays in the market’s maturity.

   • Prolonged inefficiencies would lead to losses on the short MSTR position.

2. Correlation Breakdowns

   • The strong historical correlation (~1:1) between MSTR and BTC is not guaranteed to hold.

   • If MSTR starts moving independently of BTC—due to company-specific news, changes in its Bitcoin acquisition strategy, or other factors—the hedge may fail, exposing the position to directional risk.

3. Borrowing & Carrying Costs

   • Shorting MSTR incurs borrowing fees, which can increase significantly during periods of high demand.

   • Long BTC positions, especially in futures or leveraged instruments, may also involve funding costs that eat into profits.

   • If these costs persist or rise unexpectedly, they can erode the strategy’s potential returns.

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Odds of Profits vs. Magnitude of MSTR Premium

The likelihood of the strategy’s success depends on the degree of the premium and the market’s ability to correct it.

Below are some rough estimates re: likelihood that the strategy proves effective.

Currently the premium is ~2.27x so it would be classified as “moderate.”

Low Premium: <2x

• 30-40% Chance of Profit: A modest premium offers limited room for contraction. Profits are possible but less likely.

• 40-50% Chance of Neutral Results: The small premium may remain stable, resulting in minimal change in balance after borrowing and funding costs.

• 10-20% Chance of Loss: Speculative momentum or external factors could cause slight premium expansion, leading to losses.

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Moderate Premium: 2x - 3x

• 50-60% Chance of Profit: A premium in this range has enough room for meaningful contraction, especially as market efficiency improves.

• 20-30% Chance of Neutral Results: The premium may remain unchanged, with costs eroding potential gains.

• 20% Chance of Loss: Persistent inefficiency or speculative activity could lead to further premium expansion, causing losses.

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High Premium: 3x - 4x

• 70-80% Chance of Profit: Premiums at this level are excessive, making contraction more likely as rationality returns to the market.

• 10-20% Chance of Neutral Results: Speculative interest or temporary inefficiencies could sustain the premium without major changes, leading to minimal impact.

• <10% Chance of Loss: Further expansion at this level is rare but could occur in extreme speculative environments.

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Extreme Premium: >4x

• 90%+ Chance of Profit: Premiums this large are highly unsustainable, almost guaranteeing correction and significant profits.

• <10% Chance of Neutral Results or Loss: Market irrationality could delay contraction or, in very rare cases, lead to slight expansion.

Position Sizing (Short MSTR, Long BTC)

Prudent capital allocation is critical for managing the risks associated with the short MSTR, long BTC strategy.

1. Start Small (1-5%)

If you’re just starting this trade, it may be best to limit the total % of your portfolio - as this strategy could lead to losses in scenarios where premiums persist and/or expand.

A small position ensures that you aren’t overexposed to downside.

2. Adjust Dynamically

Position sizing should evolve based on changing market conditions.

Scale Up If Conditions Improve

• Correlation between MSTR and BTC remains strong (≥0.7).

• Borrowing costs for MSTR remain low and manageable.

• The premium grows larger, offering more room for contraction and profit potential.

Scale Down or Exit If Conditions Worsen

• Correlation weakens (<0.5), making the hedge less effective.

• Borrowing costs for MSTR or funding costs for BTC rise significantly, cutting into returns.

• The premium fails to narrow within a reasonable timeframe, increasing opportunity costs.

3. Consider Risk-Reward

• Adjust the position size to reflect the estimated success probability and your tolerance for downside risk.

• Ensure the potential upside justifies the carrying costs and potential losses in worst-case scenarios.

4. Use a Structured Approach

• Regularly review your position based on updated correlation, Beta, and premium levels.

• Track the profitability of the trade and adjust the hedge ratio dynamically to maintain a delta-neutral stance.

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Strategy Design & Execution Steps

1. Pre-Trade Preparation

• Data Gathering: Confirm MSTR’s BTC holdings, current BTC spot price, MSTR’s market cap, and implied BTC price.

• Premium Verification: Check that MSTR’s implied BTC price is significantly higher (e.g., >2x) than spot. The greater the premium, the more potential profit.

• Correlation Check: Calculate recent rolling correlation (30-day, 90-day) between MSTR and BTC. Aim for ≥0.7 before committing. If correlation is ≤0.5, proceed only with caution or wait.

• Borrow Fees & Costs: Ensure MSTR is shortable at a reasonable borrow fee (<5% ideally). Check BTC futures funding or custody costs.

• Liquidity & Market Environment: Ensure both MSTR and BTC have enough liquidity to enter/exit at minimal slippage. Avoid entering during extremely illiquid periods.