What are Futures
Futures are financial contracts between two parties to buy or sell an asset at a predetermined price at a specified future date. Originating in the 19th century, these contracts were initially used in agricultural markets to stabilize prices and reduce uncertainty for farmers and buyers. Over time, futures have evolved to include a wide range of assets, including commodities, currencies, and cryptocurrencies, becoming a vital part of modern financial markets.
Futures contracts are a type of derivatives. In the context of cryptocurrencies, futures allow traders to speculate on the future price movements of digital assets like Bitcoin and Ethereum without having to own the underlying asset. This form of trading can provide opportunities for profit in both rising and falling markets, making it a popular choice among both institutional and retail investors.
What are the types of Futures?
Futures contracts can vary, but are most commonly distinguished based on their expiration date (time before the contract must be settled) and the settlement method.
Based on expiration date, futures contracts can be:
Quarterly, Monthly, Weekly, or Daily Futures: These futures contracts have a fixed expiration date at the end of each calendar quarter, month, week, and day respectively. When the contract expires, it must be settled based on the price at that time.
Perpetual Futures: A type of futures contract that doesn't have an expiration date. They allow traders to hold positions indefinitely, making them popular in cryptocurrency trading.
Based on settlement method, they can be:
Physical Delivery Futures: In physical delivery futures, the underlying asset is actually delivered at the expiration of the contract. The buyer receives the physical commodity or financial instrument, and the seller delivers it. Examples include futures contracts for commodities like gold, oil, or agricultural products.
Cash-Settled Futures: Cash-settled futures are settled in cash based on the difference between the final settlement price and the original contract price.
The underlying asset is not physically delivered, and the contract is settled through a cash payment. Unlike physical delivery contracts, these are settled in cash, meaning no actual asset is exchanged. An example is the Bitcoin futures on the Chicago Mercantile Exchange, which are cash-settled based on the Bitcoin Reference Rate.
How do Futures work?
Futures contracts work by allowing traders to lock in a price for an asset today, for delivery at a future date. This mechanism helps to hedge against price fluctuations. For example, a farmer can sell a futures contract for their crop, ensuring they get a specific price regardless of market conditions at harvest time. In cryptocurrency trading, traders can take long (buy) or short (sell) positions on futures contracts, betting on the price movement of assets like Bitcoin. Bitcoin futures contracts traded on cryptocurrency exchanges are usually perpetual futures, meaning there is no expiration date.
Futures contracts typically require a margin, a fraction of the total contract value that must be deposited before trading. The ratio between this fraction and the contract value is commonly referred to as leverage. This enables traders to open larger positions than their initial investment. This leverage can reach up to x125 on certain exchanges, meaning with an investment of $100 you would be able to open a futures position equivalent to $12500. However, it also increases the risk, as potential losses can exceed the margin amount, which inevitably leads to liquidation. Higher leverage tightens the liquidation threshold, meaning a smaller price movement in the opposite direction is required for your position to be automatically liquidated by the exchange. To avoid liquidation, professional traders safeguard their positions by placing stop-loss orders and reducing position size when faced with increased volatility.
Where can Cryptocurrency Futures be traded?
CME (Chicago Mercantile Exchange offers Bitcoin and Ethereum futures contracts, catering to traders who are not already part of the cryptocurrency market.
Binance offers perpetual and quarterly contracts with leverage up to 125x. Binance also has an auto-deleveraging system that automatically deleverages positions when there is a significant price movement, which can help prevent liquidation.
Bybit offers contracts with a pre-determined settlement date along with perpetual contracts with leverage up to x100. It also offers inverse futures for BTC/USDT and ETH/USDT trading pairs, which are settled in BTC and ETH respectively rather than USDT.
