Perpetual Futures vs Expiratory Futures
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This article is a continuation of the marginfi Leverage (learning) series.
Hello Traders! Today we’re collaborating with cypher protocol to talk about different types of futures! Cypher is building an expiratory futures platform that allows trading on historically inaccessible markets. More on how that works later.
We last talked about hedging and how it can be used to mitigate risk. One of the main tools referenced in that piece was futures. These can be used for hedging and often for short-term directional bets. The most popular tool for this latter application is perpetual futures or “perps,” but these are a rather new invention. Today, we’ll dive into the history of futures and how the main types differ.
What are Futures?
A future is a derivatives contract that obligates two parties to transact on an asset at a specific time and price. In our hedging example, MonkeDAO was obligated to buy 5000 bananas at $1 a few months down the road. Here there is a clear price, quantity, and time. This differs from options because the two parties are obligated to transact. With an option, the trader can decide whether or not to exercise, but futures do not afford this notion of choice.
A bit of background
The first instance of futures trading occurred in 1730 when the Japanese created an exchange to trade contracts on rice. Interest in agricultural futures began to pop up around the world as more exchanges and markets were opened. These markets opened around Europe and Asia and eventually led to the commodities boom of the 80s in Chicago.
Futures added a level of stability and predictability to farmers’ work which began to be adopted by all types of corporations. The contracts are still largely used by companies to hedge price risk but there are increasing instances of them being used for speculation. This rise of speculation led to the creation of perps which provide the flexibility and leverage of a future without the time constraint of an expiratory contract.
Despite the recent hype, expiratory contracts are still king and offer some unique advantages.
Expiratory futures are futures that are tied to both a predetermined price and date. They come into play when you’re looking to match your trading profile with the timing of your financial exposure, hedge against risk, and create a mechanism for future price discovery. For example, cypher protocol makes it possible to long or short pre-IPO companies through synthetic derivatives built on top of the Solana blockchain. When the protocol launches, users will be able to trade mintable cAssets — cStripe, cByteDance, and cKraken — whose price will settle at the future date in which these companies go public. In this way, these assets are expiratory: there is a settlement date built into the futures contract before two parties can even enter into the agreement.
So, why are expiratory futures the main product in traditional markets? A settlement date can help you express a more nuanced view of the market: one that’s time-bound and that allows you to better align your trades to your views or underlying exposure. Also, with expiratory futures, the concept of fluctuating funding rates concept doesn’t apply since prices will converge as the contract gets closer to settlement. As a result, expiratory futures aren’t vulnerable to the high rates of fluctuating funding rates that perpetual traders can experience.
While perps can be more volatile, they are normally the go-to for crypto traders trying to make a directional bet.
As mentioned before, perpetual futures have no expiratory date, meaning you could hold the position forever. This is advantageous if you think something will outperform in the short term, but you cannot put an exact timeline on it.
Perps are also always cash-settled and leave no option for delivery. In TradFi, the delivery could be something like thousands of barrels of oil or heaps of grain. That is known as physical delivery since the asset is trading hands in real life. Delivery can also be done with financial assets as the underlying changes hands. In the case of perpetuals though, the two parties settle up cash rather than swapping anything else.
Perpetuals are built from the ground up with no expiration, but they feature a funding rate, unlike expiratories. This rate helps the price track the underlying and fulfill counterparty obligations. More on this in our next piece!
That wraps up futures. Next, we’ll dive into funding rates which are a key component of perpetuals and a trading opportunity of their own.
As always, no marginfi content should ever be considered financial advice and no reference to financial assets, securities, derivatives, or other financial products should be considered an endorsement of the aforementioned. Please consult a licensed financial advisor before making any and all investment decisions, and please do your own research.