Perpetual futures are a derivatives contract that allow traders to speculate on the future price of the underlying asset without an expiration date
They are designed to mimic the behavior of traditional futures contracts, but without an expiration date.
They are used to speculate on the future price of assets, such as cryptocurrencies, and can be used to hedge against price fluctuations.
Let’s explore what perpetual futures are, discuss their main features and how to trade them effectively.
What is a perpetual contract?
A new type of financial instrument has emerged in recent years that offers an innovative way to trade asset prices indefinitely into the future.
Perpetual futures, also known as perpetual swaps, are futures contracts that do not have a specified expiration date.
Unlike traditional futures that expire on a specific date, perpetual futures can continue to trade as long as there are buyers and sellers.
A long position is opened when the trader believes that the price of the underlying asset will increase, and a short position is opened when the trader believes that the price of the underlying asset will decrease.
What is the funding rate?
The funding rate is the mechanism that keeps the perpetual contract price consistent with the spot price of the underlying asset.
is calculated periodically and is based on the difference between the perpetual futures price and the spot price .
If the perpetual contract price is higher than the spot price, the longs will pay the funding rate to the shorts and vice versa.
The funding rate is usually calculated every 8 hours . The funding rate a trader pays or receives depends on the difference between the perpetual contract price and the spot price of the underlying asset, as follows, as well as the prevailing market interest rate. .
Perpetual contracts are settled in cryptocurrency, usually BTC or USDT, and traders can take long or short positions depending on their market outlook.
While perpetual futures are most commonly associated with the cryptocurrency market, they can also be applied to other asset classes, including commodities, indices, and FX.
How are perpetual futures different?
- No expiry date: The most notable feature of perpetual contracts is that they have no expiry date. This allows traders to maintain their positions indefinitely without having to roll over or close out their positions as the contract nears expiration.
- Funding rate: To ensure that the price of the perpetual contract is closely consistent with the spot price of the underlying asset, a funding rate mechanism is adopted. Funding rates are typically calculated and exchanged between long and short positions every few hours to incentivize traders to maintain a balanced market.
- Leverage: Perpetual futures offer traders the ability to use leverage, allowing them to control larger positions with less capital. Leverage can magnify profits and losses, so traders must manage risk carefully.
- Margin Requirements: Traders must maintain minimum margin requirements when trading perpetual futures to cover potential losses. If a trader's margin falls below the required level, they may be liquidated, which may result in them losing their entire position.
Perpetual futures also have some risks and disadvantages.
- Without an expiration date, a position may be difficult to value relative to finite futures.
- Perpetual contracts may also have lower liquidity due to their open-ended nature.
- There is also a higher possibility of price slippage when opening or closing a position compared to standard futures contracts.
- Perpetual contracts may also require higher collateral and margin requirements as the holding period is not limited
How to trade perpetual contracts
- Choose a platform: To trade perpetual contracts, traders must first select a trading platform that offers these contracts. Many cryptocurrency exchanges and trading platforms outside the United States now offer perpetual futures for a range of assets, including digital currencies, commodities, and indices.
- Understand the contract specifications: Before trading the perpetual contract, it is necessary to be familiar with the contract specifications, including the underlying asset, contract size, minimum price increase, funding rate mechanism, etc.
- Develop your strategy: Perpetual futures can be used for a variety of trading strategies, including speculation, hedging, and arbitrage. Traders should have a clear plan based on their risk tolerance, time horizon and market outlook before entering the market.
- Manage Risk: Risk management is crucial when trading perpetual futures, especially given the potential for high leverage. Traders should use stop-loss orders, maintain adequate margin levels, and carefully monitor their positions to minimize potential losses.
Perpetual futures bring an interesting twist to the traditional futures market.
While still a niche financial product, their participation has been growing, especially in the cryptocurrency market
They offer several advantages over traditional futures contracts, including no expiry date and high leverage, but they also carry significant risks
They open up new opportunities for long-term investing and short-term trading in various asset classes.
The main benefit of perpetual futures is that they provide continuous exposure to the underlying asset with no time limit.
For long-term investors, perpetual futures eliminate the need to continually roll over positions into new monthly or quarterly contracts.
They also offer greater flexibility as investors can enter and exit positions at any time depending on their investment horizon.
For short-term traders, perpetual futures allow momentum to continue without having to wait for new contracts to expire.