What is futures?
Futures is a financial contract in which you can agree to buy or sell an asset for a specific price on a specific date. After a signed contract, both parties have to buy/sell at the price they’ve agreed despite the current market price. They are usually used as a hedging tool to mitigate the risk of price fall as well as a trading speculation vehicle.
How do they work?
Say you have a Taxi company and want to hedge against the rising price of petroleum. Fuel is sold at $4 a gallon. You expect that the price of fuel will rise and buy a four-month futures contract for 400 gallons at current price and it costs $1600.
In four months fuel costs $6 meaning the market price for 400 gallons is $2400, but you still only have to pay $1600 – you saved $800.
The main types
There are two types: deliverable and cash-settled:
- The first one requires that a buyer get a real asset (400 gallons of fuel, Apple shares, Bitcoin, etc.) at the date of expiration.
- The second only necessitates cash settlement (which is quite clear from its name), without delivery of the physical asset. This type is widely used in trading because you can speculate on the price alone.
How do they work in trading?
The logic of futures trading is mostly the same as real asset trading. Basically, you expect the price of an asset to grow or fall and then you buy or sell it. But you should do it within a certain time frame before a contract expiration date.
Let’s say, John wants to trade Apple futures during a July 1st - August 1st contract period. John can buy the futures at any point of time in this window at the market price and then sell it before August 1st – the expiration date. As a result, John will earn or lose money depending on the price of Apple shares.
Using other tactics, John can sell futures without even buying them. He expects that Apple shares will fall in price, and wants to sell a contract. In this case, he would borrow a contract from the trading platform, sell it and then buy it back at a lower price, profiting on the price difference.
Are Bitcoin futures different?
Futures is a contract bound to a certain asset. It can be securities, stock indices, commodities or even Bitcoin. As for Bitcoin futures, the contract will be based on the price of BTC and it works according to the same principles as contracts for other assets. You can use BTC futures as a hedging instrument to decrease the possible risk of losing money or to speculate.
You can play long or short:
- Long positions are based on the BTC growth forecast. A trader buys a contract at the current price and sells it at a time of growth, earning on the difference between the contract price and the price of its sale.
- A short position is used in case of an unfavourable forecast: the trader sells the contract at the current price, and then, after a decline in indices, he/she buys the contract back at a lower price. The difference between sale and purchase is the trader’s income.
Currently, there are only cash-settled Bitcoin futures on the market. However, the long-awaited trading platform Bakkt will offer contracts that mandate the physical delivery of Bitcoin after the expiration date.
Why do traders need futures?
Reading this you’re probably thinking, why the heck would I trade with futures when I can trade with real assets, including Bitcoin, if the idea is the same. If you expect BTC to grow – you buy, if you expect it to fall – you sell.
However, futures contracts have some benefits over assets trading:
- You don’t need to own BTC – futures are contracts, not real assets. You trade them without owning BTC. This means that you don’t need to worry about the safety of your cryptocurrency.
- No limits in short trading – when you are going short you need to borrow real BTC from a broker like in margin trading. For this service brokers take fees. Trading futures you don’t need to pay these fees, because you don’t borrow anything physical. They are simply agreements but not real assets showing your position.
- Leverage trading – leverage allows you to trade more money than you have on your account. At the time of the transaction, you simply do not have to pay the full value of the asset. However, it increases risks and you can lose a significant amount of funds if you calculate it wrong.
What else should I know beforehand?
The futures market has high requirements. Contracts have a high price and can be equivalent to 1 BTC, 5 BTC, etc. It depends on the exchange. Thus the market is really only available to big traders. Also, some of the platforms require (CME, CBOE) 50% as marginal security. It is very high, especially compared with the 10% margin for traditional assets.
Remember futures are for trading but not for holding, you can’t just wait until the market conditions improve. On the day of expiration, futures obligations must be fulfilled – mutual settlements between participants in the transaction are made by paying the price difference (variation margin), or the underlying asset is delivered.
Where I can trade BTC futures?
- CBOE – one of the largest trading platforms, which launched BTC futures in December 2017.
- CME – derivatives and futures exchange. Recently, it was announced that May 2019 was the best month in terms of BTC contracts trading volume on the platform since 2017.
- BitMEX – one of the biggest crypto exchanges offering BTC contracts. Unfortunately, it is not available for US citizens.
- OKEx – Hong Kong-based cryptocurrency trading platform. Offers Bitcoin futures but is not available to U.S. citizens.
- Bakkt – long-awaited exchange and custody platform backed by the NYSE. The launch has been delayed several times because of regulatory issues. They will start testing the platform this July.