What are futures contracts?
Typically, when someone buys something, the transaction is settled immediately. For example, if you give someone $100 in exchange for a certain product, that’s it. Futures contracts work a little differently, because they’re scheduled to settle on a specific date in the future for an exact amount.
Futures are legal agreements in which assets can be bought or sold at a fixed price at a specific time in the future.
A futures contract consists of two elements: the price and data of the settlement.
Once the terms of the futures contract are established, all parties involved must transact at the established price, regardless of the actual market price at the time the contract is executed.
The idea here is not to maximize profits, but to manage risk. This strategy is often used in financial markets to hedge the risk of price volatility for regularly traded items.
For this reason, futures are also used in portfolios to balance price fluctuations in investments where the primary asset is volatile in nature.
Trading and trading of these contracts takes place on futures exchanges, which serve as intermediaries.
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How do futures contracts work?
As with margin trading, there are also two positions in which a futures contract can be traded: long or short.
With a long position, the buyer agrees to buy the asset in the future at a set price when the contract reaches the expiration date. If the buyer takes a short position, he agrees to sell an asset at a specific price on the expiration date.
The seller takes the long position to get a higher price on Bitcoin when the contract expires, while the buyer aims for an overall favorable price.
The advantage here is that both parties are hedging against the volatility of the underlying asset of the contract, which is, in our case, Bitcoin.
There are also investors who speculate with futures contracts rather than using it as a hedging mechanism.
They intentionally delay when Bitcoin experiences price drops. As the price increases, the contract becomes more valuable, and the investor can choose to trade the contract before it expires, at an increased price.
What are Bitcoin futures?
With Bitcoin futures, investors can speculate and trade the price of Bitcoin without having to own Bitcoins themselves.
Futures can be traded on financial assets as well as on regular exchanges.
With Bitcoin futures, investors can base their contract on the price of Bitcoin and bet on what they think the price of Bitcoin will be in the future. Bitcoin futures work on exactly the same principles as futures that have traditional financial assets in their contracts.
This has two major implications for traders. Since Bitcoin does not have clear and uniform regulation, futures allow Bitcoin to be traded on regulated exchanges. This is an advantage for investors as they do not have to worry about the risks that can arise from the lack of regulation in Bitcoin trading.
To the trade BTC on cryptocurrency exchanges, these service providers need to comply with the laws that are installed by the country in which they operate. This can lead to many problems and inconveniences, especially if the professional is from another country that has a different set of legislative rules or if the exchange is not regulated.
Furthermore, in regions where Bitcoin trading is prohibited, Bitcoin futures offer investors a loophole through which they can still speculate on the price of the currency.
Bitcoin Futures Trading
At the moment, Bitcoin futures trading is still unregulated. However, this situation is expected to change in the future as more brokers adopt Bitcoin futures.
Currently, only a few cryptocurrency exchanges offer Bitcoin futures trading, such as Binance, a FTX Crypto Exchange. BTC futures are also offered by regulated exchanges such as the Chicago Mercantile Exchange (CME), the leading exchange for the traditional fiat economy, and the Chicago Board Options Exchange (CBOE), the largest exchange in the US.
Trading Bitcoin futures on the Chicago Mercantile Exchange involves first finding a broker who trades on the CME who will agree to place the bet on your behalf. For their service, they will also charge a fee. Your broker will then open a margin account with you.
How is the price set?
There are three main factors that decide the price of Bitcoin futures:
the validity code (the expiration date)
on offer (the purchase price)
the question (the selling price)
The entities that interact with these prices will be known as an individual speculator, market maker or arbitrageur.
A market maker is a business or institution that will act as both the buyer and seller of the traded asset. This means that the said company guarantees its clients that it will maintain the buy/sell prices at a relatively close margin.
Important details
A minimum tick size of $25 is required for each contract, meaning the price cannot vary in increments smaller than $25 per contract ($5 per Bitcoin).
There is a daily price fluctuation limit of 20% above or below the previous day's settlement price. This is done to keep runaway flash crashes limited, a phenomenon that is common on today's cryptocurrency exchanges.
Furthermore, the CME only allows a contract size to be a maximum of 5 bitcoins, so at its current price of $8,289, each contract is worth $41,445.
Considering that a 35% margin is required, you need to maintain a balance of $14,500 just to hold one futures contract.
Conclusion
While Bitcoin futures are not widely used at the moment, they may become more popular in the future as a financial tool to mitigate risk. And since Bitcoin may seem like an underwhelming asset to invest in, these contracts could give investors the confidence to start trading in the cryptocurrency world.