Brief content
Bitcoin futures contracts are a derivative product similar to traditional futures contracts. Two parties agree to buy or sell a fixed amount of Bitcoin at a certain price on a certain date. Traders use them for speculative purposes, but you can also use them for hedging. Hedging is especially popular among miners who need to cover their operating costs.
Futures are a great way to diversify your portfolio, trade with leverage and provide some stability to your future income. If you want to learn more advanced strategies with futures, pay attention to arbitrage. Cash-and-carry arbitrage and cross-exchange arbitrage, when done correctly, offer some lower-risk trading opportunities.
Introduction
Bitcoin futures contracts are an alternative investment opportunity for simple storage of coins and tokens. As a more complex product, they require a deeper understanding for safe and responsible trading. Although more difficult to use, futures provide ways to lock in prices through hedging and profit from market declines through short selling.
Do you want to apply the acquired knowledge in practice?
What are Bitcoin Futures?
Bitcoin futures are derivative financial instruments similar to traditional futures contracts. Simply put, you can agree to buy or sell a fixed amount of BTC at a certain price (forward price) on a certain date. If you open a long position (agree to buy) on a Bitcoin futures contract, and the marking price is higher than the forward price on the expiration date, you will make a profit. Marking price is the estimated fair value of an asset, calculated based on its spot price and other variables. We will talk about this in more detail later in the article.
If the strike price is below the forward price at expiration, you will lose money and profit from the short position. A short position occurs when a trader sells an asset that he has borrowed or owns in the expectation that the price will fall. The trader then buys the asset back to make a profit. You can enter into contracts physically by exchanging an underlying asset or, more popularly, through monetary settlements.
Why do people use Bitcoin futures?
One of the main uses of Bitcoin futures is the opportunity for buyers and sellers to fix future prices. This process is known as hedging. Futures have traditionally been used as hedging instruments in commodity markets where producers need a stable financial result to cover their costs.
Traders also use futures for speculation. Long and short positions allow you to make bets on the state of the market. In a bear market, you can still make money by opening a short position. There are also several opportunities for arbitrage and complex trading strategies.
Advantages of Bitcoin Futures Trading
Hedging
While hedging may seem more useful in physical commodity markets, it can also be used in cryptocurrency. Bitcoin miners, like farmers, have operating costs and rely on getting a fair price for their produce. The hedging process involves the use of both the futures and spot markets. Let's see how it works.
Futures contracts
A Bitcoin miner can take a short position on a futures contract to protect his BTC assets. After the expiration of the futures contract, the miner will have to make settlements with the other party to the agreement.
If the price of Bitcoin in the futures market (mark price) is higher than the forward price of the contract, the miner will have to pay the difference to the other party. If the marking price is lower than the forward price of the contract, the other party taking the long position will pay the difference to the miner.
Spot market
On the day the futures contract expires, the miner sells his BTC on the spot market. This sale will give it a market price which should be close to the mark price in the futures market.
However, trading in the spot market effectively cancels out any gains or losses made in the futures market. These two amounts together provide the miner with the desired hedge price. Let's combine these two steps to illustrate them with numbers.
Combination of a futures contract and a spot agreement
A miner contracts for one BTC worth $35,000 for three months. If the strike price is $40,000 on the expiration date, he loses $5,000 in the settlement paid for the long position in the contract. At the same time, the miner sells one BTC on the spot market, where the spot price is also $40,000. The miner receives $40,000, which covers his $5,000 loss, leaving him with $35,000, the hedge price.
Leverage and margin
An attractive feature for investors is margin trading. Margin allows you to borrow funds and open larger positions than you would normally be able to afford. Larger positions lead to larger profits as small price movements are amplified. On the other hand, your initial capital can be quickly liquidated if the market moves against your positions.
The exchange displays leverage as a multiplier or percentage. For example, 10x multiplies your capital by 10. So $5,000 with a leverage of 10x gives you $50,000 to trade. When you trade with leverage, your initial capital covers your losses (also known as margin). Let's look at an example:
You buy two quarterly Bitcoin futures contracts for $30,000 each. Your exchange allows you to trade them with a leverage of 20x, which means you are only providing $3,000. This $3,000 acts as your margin, and the exchange will take your losses from it. If you lose more than $3,000, your position will be liquidated. You can calculate the margin percentage by dividing 100 by the leverage ratio. 10% is 10X, 5% is 20X, 1% is 100X. This percentage shows how much the price can fall compared to the price of your contract before it was liquidated.
Portfolio diversification
With Bitcoin futures you can diversify your portfolio and use new trading strategies. It is recommended to build a well-balanced portfolio for different coins and products. Futures are attractive for the various trading strategies they offer you, not just for holding. There are also lower-risk, lower-margin arbitrage strategies that can reduce the overall risk of your portfolio. We will discuss these strategies a little later.
Are you ready to start trading?
Bitcoin futures on Binance
Not all futures contracts are the same. Different exchanges have different mechanisms, expiration dates, prices and commissions for their futures products. Currently, Binance offers several options that differ mainly in terms of validity and funding.
Expiry date
Until now, we have mentioned only futures with a specific expiration date. The Binance futures exchange has quarterly futures, but you can find monthly and semi-annual expiration dates (expiration dates) on other exchanges. You can quickly check when a contract will expire by its name.
Quarterly Bitcoin futures contracts on the Binance exchange have the following calendar cycle: March, June, September and December. The BTCUSD Quarterly 0925 contract expires on 09/25/2021 at 08:00:00 UTC.
Another popular option is trading in perpetual futures without an expiration date. Profits and losses are handled differently than quarterly futures and include financing fees.
Funding commission
When you buy quarterly Bitcoin futures on Binance, you need to maintain margin to cover any possible losses. However, you will pay this loss only upon liquidation or expiration of the contract. In the case of a perpetual futures contract, you must also pay or receive a funding fee every eight hours.
Funding fees are peer-to-peer payments to traders. These rates prevent the divergence between the forward price of the Bitcoin perpetual futures contracts and the strike price. The marking price is similar to the BTC spot price, but is designed to prevent unfair liquidation that can occur when the market is highly volatile.
For example, a single trade in the spot market can temporarily raise the price by thousands of dollars. This volatility may lead to the closing of futures positions, but will not accurately reflect the actual market price. You can see the funding rate highlighted in red below and when it expires.
A positive funding rate means that the price of the perpetual contract is higher than the markup price. When the futures market is bullish and the funding rate is positive, traders with long positions pay commissions to fund short positions. A negative funding rate means that prices for open-ended contracts are lower than the markup price. In this case, short positions pay a commission to long positions.
To learn more about the funding rate, which can be quite a complex topic, read the article Introduction to Binance Futures Funding Rates.
COIN-M futures and USDⓈ-M futures
Binance offers two futures trading options: COIN-M futures with cryptocurrency as margin and USDⓈ-M futures with BUSD/USDT as margin. Both types of contracts are available indefinitely, but there are slight differences between them.
COIN-M futures must use the underlying asset of the contract as collateral for your futures margin account. However, USDⓈ-M futures allow cross hedging. This feature allows you to borrow USDT and BUSD at 0% using the crypto assets in your spot wallet as collateral.
COIN-M futures are usually more popular among miners seeking to hedge their Bitcoin positions. Since settlements are done in cryptocurrency, there is no need to transfer their BTC to stablecoins, adding an extra step to the hedging process.
How to start trading Bitcoin futures contracts?
If you want to start trading Bitcoin futures on Binance, all you need to do is create an account and get some funds. Here's a step-by-step guide to getting your first Bitcoin futures contract:
1. Create a Binance account and enable 2FA (two-factor authentication). If you already have an account, make sure 2FA is enabled so you can deposit funds into your futures account.
2. Buy some BUSD, Tether (USDT), or supported cryptocurrencies for futures trading. The easiest way to do this is to purchase them with a debit or credit card.
3. Go to the Bitcoin futures interface and select the type of contract you want to buy. Choose between COIN-M or USDⓈ-M futures, as well as perpetual or expired futures.
4. Choose the size of the leverage that is convenient for you. You can do this to the right of the [Cross] button in the trading interface. Remember that the higher the leverage, the more likely you will be liquidated by small price fluctuations.
5. Select the amount and order type you want to use, then click [Buy/Long] or [Sell/Short] to open your Bitcoin futures position.
For more detailed instructions, see The Complete Guide to Trading Binance Futures.
Bitcoin Futures Arbitrage Strategies
We've covered the basics of long and short trading, but that's not all you can do. Futures contracts have a long history of arbitrage strategies similar to the forex markets. Traders use these methods in traditional markets, and they are also suitable for cryptocurrencies.
Interexchange arbitration
When different cryptocurrency exchanges have different prices for futures contracts, an arbitrage opportunity arises. By buying a cheaper contract on one exchange and selling a more expensive one on another, you can profit from the difference.
For example, imagine that BTCUSD Quarterly 0925 on Binance is $20 cheaper than another exchange. By buying a contract on Binance and selling it for a higher price on another exchange, you can arbitrage the difference. However, prices change really quickly due to automated trading robots. You need to act fast, as any difference may disappear while you're making deals. Also, factor in any fees you may have to pay when calculating your profit.
Cash-and-carry arbitrage
When it comes to futures, cash-and-carry arbitrage is nothing new and is a neutral market position. Neutral market positions imply the simultaneous purchase and sale of an asset in equal quantities. In this case, the trader opens a long and short position on an equal number of identical futures contracts, regardless of their price. Cryptocurrency futures offer significantly higher profit margins for cash-and-carry arbitrage than traditional commodity futures.
Trading efficiency is much lower compared to older markets and wider arbitrage opportunities. To use this strategy successfully, you need to find a point where the BTC spot price is lower than the futures price.
At this stage, simultaneously open a short position on the futures contract and buy the same amount of Bitcoin on the spot market to cover your short position. When the contract reaches expiration, you can settle the short position with the Bitcoin you bought and receive the arbitrage difference.
So why does this opportunity even exist? People are willing to pay a higher futures price if they don't have the money to buy BTC now, but they think the price will go up in the future. Let's say you think that in three months BTC will be worth $50,000, but currently it is $35,000.
At the moment you have no money, but in three months you will. In this case, you can open a long position with a small premium of $37,000 with delivery within three months. Cash-and-carry arbitrage essentially holds BTC for you for a fee.
Trading doesn't have to be complicated
Final thoughts
Bitcoin futures trading takes proven derivatives from traditional finance and brings them to the world of cryptocurrencies. Cryptocurrency futures markets are currently extremely popular and make it easy to find trading platforms with high trading volume and liquidity. However, trading in the Bitcoin futures markets involves a high level of financial risk, so make sure you understand the workings of futures trading before you start.
