Perpetual futures are a type of derivative contract that allows traders to speculate on the future price of an underlying asset without an expiration date

They are designed to mimic the behavior of a traditional futures contract, but without an expiration date.

They are used to speculate on the future price of an asset, such as a cryptocurrency, and can be used to hedge against price fluctuations.

Let’s explore what perpetual futures are, discuss their key features, and how to trade them effectively.

What are perpetual futures?

A new type of financial instrument has emerged in recent years that provides an innovative way to trade asset prices indefinitely into the future.

Perpetual futures, also known as perpetual swaps, are futures contracts with no specified expiry date.

Unlike traditional futures that expire at a particular date, perpetual futures can continue trading as long as there are buyers and sellers.

Long positions are opened when traders believe that the price of the underlying asset will increase, while short positions are opened when traders believe that the price of the underlying asset will decrease.

What is the funding rate?

The funding rate is the mechanism that keeps the perpetual futures price in line with the spot price of the underlying asset.

It is calculated periodically and is based on the difference between the perpetual futures price and the spot price of the underlying asset.

If the perpetual futures price is higher than the spot price, long positions will pay a funding rate to short positions, and vice versa.

The funding rate is typically calculated every 8 hours, and the amount of funding rate paid or received by the trader depends on the difference between the perpetual futures price and the spot price of the underlying asset, as well as the prevailing interest rates in the market.

Perpetual futures contracts are settled in cryptocurrency, typically BTC or USDT, and traders can enter 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 forex.

What makes perpetual futures different?

  • No Expiration Date: The most distinguishing feature of perpetual futures is the absence of an expiration date. This allows traders to maintain their positions indefinitely, without the need to roll over or close out contracts as they approach expiry.
  • Funding Rate: To ensure that the perpetual futures price remains closely aligned with the underlying asset’s spot price, a funding rate mechanism is employed. The funding rate is typically calculated and exchanged between long and short positions every few hours, incentivizing traders to maintain a balanced market.
  • Leverage: Perpetual futures offer traders the ability to use leverage, enabling them to control larger positions with a smaller amount of capital. Leverage can magnify both profits and losses, making it essential for traders to manage their risk carefully.
  • Margin Requirements: Traders must maintain a minimum margin requirement when trading perpetual futures to cover potential losses. If a trader’s margin falls below the required level, they may be subject to liquidation, which could result in the loss of their entire position.

Perpetual futures also come with some risks and downsides.

  • Without an expiry date, positions can be difficult to value relative to finite futures.
  • Liquidity may also be lower for perpetual contracts given their open-ended nature.
  • There is also a higher possibility of price slippage when entering or exiting positions compared to standard futures contracts.
  • Perpetual futures may also require higher collateral and margin requirements due to the unlimited duration of positions

How to Trade Perpetual Futures

  1. Choose a Platform: To trade perpetual futures, traders must first select a trading platform that offers these contracts. Many cryptocurrency exchanges and trading platforms outside the U.S. now provide perpetual futures for a range of assets, including digital currencies, commodities, and indices.
  2. Understand the Contract Specifications: Before trading perpetual futures, it’s essential to familiarize yourself with the contract specifications, including the underlying asset, contract size, minimum price increment, and funding rate mechanism.
  3. Develop a Strategy: Perpetual futures can be used for various trading strategies, including speculation, hedging, and arbitrage. Traders should develop a clear plan based on their risk tolerance, time horizon, and market outlook before entering the market.
  4. Manage Risk: Risk management is crucial when trading perpetual futures, particularly given the potential for high leverage. Traders should employ stop-loss orders, maintain adequate margin levels, and carefully monitor their positions to minimize potential losses.

Summary

Perpetual futures provide an interesting twist to traditional futures markets.

While still a niche financial product, their participation has been growing, especially in crypto markets

They offer several advantages over traditional futures contracts, including no expiration date and high leverage, but they also carry significant risks

They open up new opportunities for both long-term investing as well as short-term trading across various asset classes.

The key benefit of perpetual futures is that they provide constant exposure to the underlying asset without time limits.

For long-term investors, perpetual futures eliminate the need to keep rolling over positions into new monthly or quarterly contracts.

They also provide more flexibility as investors can enter and exit positions at any time based on their investment horizons.

For short-term traders, perpetual futures allow riding momentum for as long as it lasts without waiting for new contract expiries.