Crypto Futures
What Are Crypto Futures
Crypto futures are contracts that let traders speculate on the future price of cryptocurrencies without needing to own the actual coins. These contracts obligate the buyer to purchase or the seller to sell a specific cryptocurrency at a predetermined price on a future date. The value of the contract is based on the price of the underlying cryptocurrency, making it a popular tool for traders who want to trade in the crypto market without holding the actual asset.
A futures contract is a legal agreement that outlines the details of the trade, such as the asset, price, and expiration date. Traders can use leverage, which means they can control a position larger than their initial investment. For example, with 10x leverage, a trader can open a position worth 10 times their own money, which can increase both potential profits and losses. To enter and maintain a futures trade, traders need to provide a margin, which is the capital required to back the trade. The initial margin is the amount needed to start the trade, and the maintenance margin is the minimum amount needed to keep it open. If the market goes against the trader, they may need to add more funds to avoid losing their position, known as a margin call.
Crypto futures offer benefits like leverage, allowing traders to gain significant exposure with a smaller investment, and hedging, which helps traders protect their portfolios against price changes by taking opposite positions in the futures market.
How Crypto Futures Work
Crypto futures work by allowing investors to speculate on the future price of a cryptocurrency. For example, let's say that you believe that the price of Bitcoin will increase in the future. You can open a crypto futures contract that allows you to buy Bitcoin at a set price at some point in the future.
If the price of Bitcoin does increase, you will be able to buy it at a discounted rate and then sell it for a profit. However, if the price of Bitcoin falls, you will still be obligated to buy it at the agreed-upon price, potentially leading to a loss. Crypto futures can be a risky investment, but they can also lead to big profits if used and timed correctly.
There are three main things that you need to pay attention to when it comes to buying and selling cryptocurrency futures contracts.
Expiration/Settlement date
This is the date when the futures contract must be settled. While traders can buy and sell these contracts before the settlement date, the settlement date serves as a line in the sand for the date that the transaction has to be settled.
Units per contract
This details how much each crypto futures contract is worth of the underlying asset. The units per contract differ from platform to platform. For example, one Bitcoin futures contract on Deribit equals 10 US dollars worth of Bitcoin while one Bitcoin futures contract on CME equals 5 Bitcoin.
Leverage
Traders can use leverage to increase their speculation and trading size on futures contracts. The amount of leverage afforded to traders depends on the platform.
How Long Can You Hold Crypto Futures
Crypto futures contracts have expiration dates, which determine the length of time you can hold the contract. These expiration dates range from a few days to several months or even longer, depending on the contract type and the cryptocurrency being traded.
It's important to note that as the contract approaches its expiration date, traders have the option to either close their positions or roll them over into new contracts with later expiration dates if they wish to extend their holding period. However, it's crucial to closely monitor the contract expiration dates and manage your positions accordingly to avoid any unwanted liquidations or contract settlements.
An Example Of Crypto Futures
To illustrate how crypto futures work, let’s use an example.
Bob, an experienced trader, believes that the price of Bitcoin (BTC) will increase in the future. He decides to take a long position in BTC futures contracts to potentially profit from this anticipated price rise.
Assuming the current price of BTC is $35,000, and Bob expects it to reach $40,000 within the next month so he opens a BTC futures contract. The contract specifies that he will buy one BTC at the agreed-upon price of $35,000, with an expiration date one month from the trade initiation.
Let’s say that the margin requirement for Bitcoin futures trading at the trading platform that Bob is trading at is 50% of the contract amount, he has to deposit $17,500 as margin and finance the rest of the contract purchase by using leverage if he so chooses.
Assuming that Bitcoin's price reaches his target price of $40,000 and Bob sold his BTC futures contract at that market price.
Since Bob bought the contract at $35,000 and sold it at $40,000, he will make a profit of $5,000 per BTC futures contract.
On the other hand, if the price of BTC had declined to $30,000 instead of rising, Bob would have faced a loss. In this case, he could choose to either close the position and accept the loss or wait until the contract expiration date in the hope that the price might rebound.
Advantages Of Crypto Futures
Crypto futures have become increasingly popular in recent years due to the many advantages they offer traders.
Crypto futures contracts allow traders to bet on the future price of a cryptocurrency, without having actually to purchase the underlying asset. This allows traders to speculate on the future price movements of a cryptocurrency without incurring the high costs associated with buying and holding the asset itself.
Crypto futures also offer greater flexibility than traditional futures contracts, as they can be traded on a variety of different exchanges and platforms.
In addition, crypto futures offer increased liquidity and higher leverage ratios than most other types of derivatives. The higher leverage that crypto futures offer means that traders can control larger positions with a smaller amount of capital, potentially magnifying profits.
How Risky Are Crypto Futures
Crypto futures trading can allow you to leverage your returns but the leverage also applies to the downside. The key is to make sure that you educate yourself and trade carefully, knowing the risk and what you can afford to lose.