Inverse Futures Contracts: Optimize Your Trades Today

Whether you are looking to hedge or increase leverage, utilizing different derivatives instruments creates opportunities to better manage risks and capture profit. 

Such trading strategies, however, involve risks. Please perform due diligence before incorporating them into your portfolio.

Arbitraging Between Spot and Futures Markets 

Given the volatility of crypto assets, the pricing inefficiencies and trading sentiments may render the spot price of an asset to deviate significantly from the futures price. 

For traders, the larger the difference (basis), the better the opportunity to arbitrage. This strategy allows secured profits regardless of price movement since futures price will converge to spot price as expiry approaches.

Let’s run an example. Say that BTC’s spot price is $55,000 and BTCUSD0625 Futures Contract is priced at $65,000 on Bybit. 

To arbitrage, you decide to purchase 1 BTC in the spot market and transfer it to Bybit. You then enter a short position on 1 BTC worth of BTCUSD0625 Futures Contracts priced at $65,000. 

You will earn the full basis of $10,000 (65,000 – 55,000) regardless of any price movements. 

If BTC price rises to $65,500 upon Futures expiry, your realized loss on the BTCUSD0625 Futures Contracts would then be 0.0076 BTC {65,000 x (1/65,500 – 1/65,000)}, or approximately $498. 

Yet, because the value of the underlying asset increases, your realized loss on the BTCUSD0625 Futures Contracts will be offset by the $10,500 (65,500 – 55,000) profit when you sell the underlying asset back on the spot market.

This spot-futures arbitrage strategy allows you to lock in a return of $10,002 (10,500 – 498) on your investment. 

The opposite situation is also valid. If the price tanks, you can close your positions on BTCUSD0625 Futures Contracts with a profit — even though the value of the underlying asset plunges. Either way, your return on investment will be irrelevant to BTC’s price direction.  

Capitalizing On Interest Rates

The funding rate on BTCUSD Perpetual Contract, calculated every eight hours, represents a short-term floating interest rate. The basis on a BTCUSD0625 Futures Contract, on the other hand, signifies a longer-term interest rate. 

By taking offsetting positions in these two markets, you can balance out losses from one with gains in another, while betting on the differences between short-term and long-term interest rates.

Let’s run an example. On March 1, the BTC spot price is $50,000. BTCUSD0625 is traded at $55,000, a 10% premium relative to the spot price. 

You enter 1 BTC worth of short position on BTCUSD0625 Futures Contracts priced at $55,000, and 1 BTC worth of long position on BTCUSD Perpetual Contracts at $50,000. 

Assume that on March 10, the BTC spot price and Perpetual Contract price remain at $50,000. However, BTCUSD0625 Futures price drops to $53,000, a 6% premium relative to the spot price.  

For BTCUSD0625 short position, you will secure 0.038 BTC {55,000 X (1/53,000 – 1/55,000)} profit from premium narrowing (roughly 3.8%).

For BTCUSD long position, let’s assume the funding rate for this contract is 0.01% for every eight hours. Over the time period of 10 days, you will have to pay a funding fee of roughly 0.3% (0.01% x 3 x 10) of your long position value.

By trading the difference between the long-term rate (Futures Contracts premium) and short-term rate (Perpetual Contracts funding fee), your net profit on interest rate speculation equals 3.5% (3.8% – 0.3%) of your position value.

However, interest rate arbitrage doesn’t guarantee a profit. In this instance, you may lose money if the funding rate goes higher than your expectation or if the futures premium further widens out.  

All derivative products have their own perks and risks. The ability to trade products rationally based on your investment style and rein on risk within a reasonable range is essential to a good investor.