EXPLAINER: What Are Perpetual Futures Contracts?
Derivatives have been around for many centuries and form an essential part of global financial markets. What makes derivatives special is that they enable traders to make a profit, even if the price of the underlying asset goes down. This is different from ordinary spot trading.
The reason for this special capability is that with derivatives trading, rather than investing in the asset itself, you are investing in an expectation. If you expect the price of the asset to go down, you ‘go short’; and if you expect the price to go up, you ‘go long’. If you’re right, you can make a profit.
There are many types of derivatives but in this post we want to focus specifically on perpetual contracts and discuss how you can use this type of derivative to your advantage.
What are perpetual futures contracts?
Whereas an ordinary futures contract constitutes an agreement to buy a certain asset at an agreed price, at a specific time, a perpetual futures contract has no expiry date. In other words, if you take up a position in the perpetual futures market (either going long or short), you can hold that position for as long as you want to — provided you do not get automatically liquidated.
What is ‘Margin’?
Your margin is simply the amount you take from your personal balance to put into the market. So, if you put in 0.1 Bitcoin (BTC), your margin is 0.1 BTC. If the market does not develop as you expect, at most you can lose your margin. With AAX you can never lose more than your margin.
What does it mean to trade with leverage?
With AAX, you can trade with up to 100x leverage. This means that if you put in 1000 USD, you can effectively enter the market with 100,000 USD. This is attractive for obvious reasons: If you enter the market with 1000 USD and close your position once the price has risen by 2%, you will have made 20 USD profit (excluding commission fees). If, however, you trade with a 100x leverage, that 2% would have yielded 2000 USD.
What happens if the price of a perpetual futures contract goes differently than expected?
If you go long, but the price goes down, or if you go short, and the price unexpectedly goes up, there is a chance that you will be automatically liquidated. In other words, you may lose your margin. The reason for this is that with AAX you can never lose more than your margin, so once you come near to your point of maximum loss (= your margin), AAX will automatically close your position to protect you from further loss.
For example, if you’ve gone long with 100 USD and the price unexpectedly goes down, you can maintain your position in the hope that the price will recover. But if you come too close to losing your 100 USD margin, AAX will close your position automatically. If you trade with leverage, so let’s say, you’ve put in 1 USD with 100x leverage (= 100 USD), then AAX will close your position right before you stand to lose that 1 USD.
As you can see from this calculation: trading with leverage is a way to significantly amplify your profit, but it is also riskier. How much leverage you use is therefore dependent on how certain you are about future price movements.
If you fear being liquidated automatically, you can choose to adjust your leverage to reduce the chance of getting liquidated, or you can close your position yourself.
How can perpetual futures contracts be used?
Perpetual contracts can be used in a number of ways.
Firstly, if you hold Bitcoin and you see that the price of Bitcoin is going down, then instead of selling at a loss, or ‘hodling’ in the hope of a price recovery, you can simply ‘go short’ on the Bitcoin futures market to stabilize your portfolio. In other words, you can use perpetual contracts to hedge against your position in the spot market.
Secondly, the futures market enables you to trade in all market conditions. You can make a profit in a bull market, as well as in a bear market.
Thirdly, with leverage, you can amplify your profits significantly.
What futures contracts does AAX support?
AAX currently lists 5 perpetual futures contracts:
- Bitcoin (BTC/USD)
- Ether (ETH/BTC)
- Litecoin (LTC/BTC)
- XRP (XRP/BTC)
- EOS (EOS/BTC).
What is the price of 1 contract?
For both BTC and ETH, the price of 1 contract is 1 USD worth of BTC. For LTC, XRP, and EOS, the price per contract is 1 LTC, 1 XRP, and 1 EOS worth of BTC, respectively.
All contracts are quoted and settled in BTC.
Where can I learn more about futures trading on AAX?
If you want to learn more about trading perpetual contracts on AAX, please refer to our Futures Guide for Beginners. If you want to learn more about the fee structure and other specific details, please refer to our Helpdesk.
Originally published at https://academy.aax.com on September 30, 2019.
