In the world of crypto trading, derivatives contracts are investments that derive their values from an underlying cryptocurrency, such as bitcoin or ether.
These contracts enable traders to speculate on the price fluctuations of the cryptocurrency without directly possessing the asset.
Futures and perpetual contracts are among the most prevalent forms of crypto derivatives.
What are crypto futures?
Futures contracts are agreements in which the “short” party is obligated to deliver the asset to the “long” party at a predetermined price on a future date, in contrast to spot trading in crypto, where the asset can be exchanged immediately.
This can be especially beneficial for individuals who are interested in leveraging their positions to increase returns or hedging against market volatility.
Nevertheless, the high volatility of cryptocurrency prices poses a substantial risk to crypto futures, particularly when leverage is employed, as it can result in rapid and substantial losses.
These risks can be further exacerbated by the potential for market manipulation and limited liquidity, which can make it challenging to exit positions at favorable prices.
What are perpetual contracts?
In essence, perpetual contracts, which are also referred to as “perps,” are futures contracts that do not have an expiration date.
This enables traders to maintain a position indefinitely, provided that they can account for the funding rate, which is a charge paid periodically to balance the price of the perpetual contract with the spot price. In addition, traders must maintain the sufficient margin.
The funding rate guarantees that the trading price of the perpetual contract is inextricably linked to the market price of the underlying asset.
In order to effectively manage their positions, traders who are involved in perpetual contracts must remain vigilant about market movements and funding rate intervals, which are frequently as brief as eight hours.
Traditional futures are defined by their expiration and settlement dates, whereas perpetual contracts are perpetually renewed.
This implies that dealers in perps can circumvent the limitations of time-bound contracts and have the ability to adjust to ongoing market developments. Perpetual contracts are particularly appealing to traders who are interested in capitalizing on short-term price fluctuations.
In cryptocurrency trading, how does one employ futures and options?
In crypto trading, investors have the option of utilizing futures contracts and perps for hedging and speculation.
They can speculate on the future price movement of cryptocurrencies without possessing the underlying assets by taking long or short positions in these contracts. As a result, investors can capitalize on either rising (when long) or declining (when short) markets.
Investors may implement these contracts for portfolio diversification and risk management, in addition to speculation.
By hedging their positions, they can safeguard against adverse price movements in the underlying cryptocurrency, such as shorting futures to counter potential losses from holding the actual asset.
Furthermore, futures and options offer investors exposure to a wider variety of assets, allowing them to diversify their portfolios without the need to own the cryptocurrencies.
