Bitcoin Futures and How to Trade Them
Crypto futures are a kind of financial contract used to bet on market movements, but they're high risk. Learn about crypto futures and derivatives in our guide.
What is a crypto derivative?
Derivatives are financial contracts set between multiple parties that ‘derive’ their value from an underlying asset or benchmark.
The contract is signed between two or more parties wanting to buy or sell a particular asset for a specific price. The value of the contract is determined by fluctuations in the price of the benchmark it derives its value.
Often these underlying assets used in derivatives are currencies, commodities, bonds, stocks, market indexes, or - in this instance - cryptocurrencies.
Are there different kinds of crypto derivatives?
Yes, there are different types of crypto derivatives:
Futures: A futures contract is an agreement between two parties, or people, to purchase or sell an underlying asset at a specified price and date in the future. This is the type of derivative we’ll be covering in-depth in this guide.
Options: Options are like futures, but rather than having an obligation, they have a choice. In other words, options grant the buyer the right, but not the duty, to purchase or sell the underlying asset at a certain price. Learn more about Bitcoin options in our dedicated guide.
Perpetual swaps: Also known as perpetual futures, swaps are a type of derivative contract that allows traders to speculate on the future price of an asset without an expiration date. Unlike traditional futures contracts, which have a set expiry date, perpetual futures can be held indefinitely.
What are Bitcoin futures?
Futures contracts are derivative financial instruments that obligate a buyer to purchase an underlying asset at a specified price on a specific date - even if the value of the underlying asset has depreciated relative to their agreed price. Likewise, the seller must also sell the underlying asset at the agreed price, even if the value of the underlying asset has appreciated relative to their agreed price.
While Bitcoin is the most common underlying asset in crypto futures, there are other altcoin futures contracts available, like Ethereum.
In a volatile market, crypto futures represent an opportunity to bet on market movements for both buyers and sellers who are confident that an asset will appreciate or depreciate in value.
How do Bitcoin futures work?
Bitcoin futures are easiest to understand with an example.
Let’s say Bitcoin is currently priced at $40,000. You can buy or sell a Bitcoin futures contract, depending on whether you think the price of Bitcoin will rise or fall.
You think it will rise so you buy a Bitcoin futures contract, representing one Bitcoin at $40,000. There are two ways this plays out:
You were right, the price of Bitcoin rises to $60,000 by the expiry date of your futures contract. You’ve made a $20,000 profit.
You were wrong, the price of Bitcoin fell to $30,000 by the expiry date of your futures contract. You’ve made a $10,000 loss.
This is a fairly simple explanation, so let’s dive into some more of the terminology around Bitcoin futures to help you understand it more.
Bitcoin futures terminology
There are several terms you’ll see crop up relating to Bitcoin futures that are helpful to understand:
Going long: Also commonly referred to as a long position, or just long. It refers to a contract where the buyer thinks the price of an asset will rise.
Going short: Also commonly referred to as a short position, or just short. It refers to a contract where the buyer thinks the price of an asset will fall.
Underlying asset: This one is obvious. This is the asset that you’re contracting to buy or sell. For example, BTC or ETH for crypto futures.
Contract size: The contract size specifies the amount of the asset you’ll buy or sell. For example, 1 BTC or 1 ETH.
Settlement procedure: A futures contract can be settled by delivery or by transfer of cash position. In the former, you’d receive the amount of the underlying asset you’ve specified in your contract. In the latter, the monetary difference from your position would be delivered, so if the price of BTC had risen relative to your position, you’d receive the difference.
Price limit: Also referred to as limit up and limit down. These are the maximum amounts a contract can increase or decrease in a day. If the market hits a price limit, an exchange may halt trading temporarily.
Position limits: Position limits are the maximum number of contracts an investor can have.
Minimum price fluctuation: Commonly known as a tick, it refers to the minimum increment of price movement possible in a given futures contract. Tick value is also important to understand as it can help you calculate profit and loss. It’s calculated by multiplying the tick size by the size of the contract.
Profit and Loss: Also known as PnL. It refers to the gain or loss you’ve made from a specific contract (Profit or Loss per Contract = Number of Ticks Moved × Value of a Tick)
Notional value: The total value of a futures contract, calculated as the product of contract unit and contract price (Contract Notional Value = Contract Unit × Contract Price). Notional value can help you gauge the hedge ratios versus other futures contracts.
Hedge ratio: A risk management tool determining the exposure needed to be hedged in relation to the contract notional value and value at risk (VaR). (Hedge Ratio = Value at Risk/Contract Notional Value)
Value at risk: A statistical measure of the maximum potential loss of funds for a portfolio over a given period. There are different ways to calculate this.
What happens when a Bitcoin futures contract ends?
While we said before that those involved in futures trading are obligated to buy the contract, it’s not quite the case. There are actually three choices when it comes to a Bitcoin futures contract expiring:
Settling a contract: If neither buyer nor seller changes their position, the futures contract expires and settles. The seller must deliver the underlying asset under the settlement method agreed upon in the contract.
Offsetting the position: One of the most common ways of exiting a futures contract is via offsetting. To offset a position, you open a position of equal value in the opposite direction. For example, if you had a Bitcoin futures contract to buy, you’d also have a Bitcoin futures contract to sell - both for the same price. The difference in price between the initial position and offset position indicates the profit or loss overall. Investors can avoid delivery of the asset by ending the contract before the expiration date. It’s also sometimes referred to as liquidation.
Rolling over a contract: If an investor wants to maintain their position, they can roll it toward. For example, if you had a Bitcoin futures contract that expired in three months, you could sell it and buy a contract for six months.
How do people make money from Bitcoin futures?
Investors profit from Bitcoin futures by betting in the right direction for Bitcoin price movements.
For example, if you’d opened a long position to buy Bitcoin, you’re betting the price of Bitcoin will increase in the future. So you buy a contract to purchase Bitcoin at its current price, expecting the price to rise. You hold the contract until the expiration date and (if the price has risen) you pocket the difference and profit from the price increase.
The opposite is true for a short position. In a short position, you’re betting the price of Bitcoin will fall, and pocketing the difference between the price you sold Bitcoin at and the price decrease.
How to trade Bitcoin futures
Many exchanges offer Bitcoin futures and other crypto futures. You can learn more in our best platforms for Bitcoin futures guide.
Bitcoin futures trading strategies
There are many strategies available for investors trading futures contracts. Some of the more common strategies include:
Day trading: Traders open and close positions within the same trading day to profit from short-term price movements. Typically involves making numerous small trades to capture small price fluctuations.
Swing trading: Traders aim to profit from medium-term price swings over several days or weeks. Positions are held for a longer duration compared to day trading.
Trend following: Traders identify and follow established trends, going long in bull markets and short in bear markets. Technical analysis tools, such as moving averages, are often used to identify trends.
Contrarian trading: Traders take positions opposite to prevailing market sentiment, assuming that crowded trades may reverse. Contrarians buy when sentiment is extremely bearish and sell when sentiment is overly bullish.
Arbitrage: Traders exploit price differences between Bitcoin futures and spot markets to make risk-free profits.
Hedging: Investors use Bitcoin futures to protect their cryptocurrency holdings from adverse price movements.
Pairs trading: Traders simultaneously take long and short positions on related assets, such as Bitcoin and altcoins. The goal is to profit from relative price movements between the two assets.
Breakout trading: Traders identify key support and resistance levels and enter positions when Bitcoin's price breaks through these levels.
Range trading: Traders identify a trading range where Bitcoin's price moves within a defined range. They buy near support levels and sell near resistance levels.
Algorithmic trading: Automated trading programs execute trades based on predefined algorithms and criteria. These algorithms can analyze market data and execute trades much faster than humans.
What are the benefits of Bitcoin futures?
There are many pros for investors trading Bitcoin futures:
Risk Management: Bitcoin futures allow investors to hedge against price volatility, reducing the risk associated with holding Bitcoin.
Speculation: Traders can profit from both rising and falling Bitcoin prices by taking long (buying) or short (selling) positions in futures contracts.
Liquidity: Bitcoin futures markets often have high liquidity, providing ample opportunities to enter and exit positions with ease.
Leverage: Futures contracts allow traders to control a larger position with a smaller amount of capital, potentially magnifying profits (but also losses).
Diversification: Investors can include Bitcoin futures in their portfolio to diversify and gain exposure to cryptocurrency without holding physical assets.
Regulated environment: On many established exchanges, Bitcoin futures are traded in a regulated environment, providing investor protection and transparency.
Arbitrage opportunities: Traders can capitalize on price discrepancies between futures and spot markets through arbitrage strategies.
What are the risks of Bitcoin futures?
Bitcoin futures are a high-risk investment. Some of the most notable risks include:
Price volatility: Bitcoin (and other cryptocurrencies) is known for its price volatility, and futures contracts amplify both potential gains and losses, making them riskier.
Leverage: While leverage can magnify profits, it also increases the potential for substantial losses. Traders can lose more than their initial investment.
Market liquidity: In periods of extreme volatility, liquidity can decrease significantly, leading to wider bid-ask spreads and difficulty in executing orders.
Regulatory changes: Regulations surrounding Bitcoin and cryptocurrency futures can change, impacting trading rules and investor protections.
Counterparty risk: Bitcoin futures involve counterparty risk, where the investor relies on the exchange or broker to fulfill the contract terms.
Inadequate knowledge: Inexperienced traders may lack the necessary knowledge and expertise to navigate the complexities of futures trading effectively.
Market sentiment: Speculative trading in Bitcoin futures can be influenced by market sentiment and emotions, leading to unpredictable price swings.
Overtrading: Excessive trading or high-frequency trading strategies can lead to increased transaction costs and potential losses.
And one last warning - your profits from Bitcoin and crypto futures will be subject to tax.
What’s the difference between crypto futures and crypto options?
The easiest way to understand the differences between spot trading and futures trading is to compare the two:
|Buying or selling the actual asset at the current market price.
|Buying or selling a contract for the future delivery of the asset at a predetermined price.
|Immediate, with ownership of the asset transferred upon trade execution.
|Can be settled either through physical delivery of the underlying asset or cash settlement based on contract terms.
|Immediate ownership of the asset is obtained in spot trading.
|No ownership of the underlying asset until the futures contract is settled.
|Full exposure to the asset's current market price.
|Exposure to the asset's future price, allowing both long (buy) and short (sell) positions.
|Typically no leverage in spot trading.
|Leverage is commonly used in futures trading, enabling control of larger positions with a smaller amount of capital.
|Limited risk management tools available in spot trading.
|Extensive risk management tools, including stop-loss orders and options strategies, are available in futures trading.
|Often used for investment, as well as immediate use or transfer of assets.
|Used for speculation, hedging, and risk management.
How are Bitcoin futures taxed?
We have a whole article dedicated to the tax implications of crypto futures. But in brief, it depends on whether you’re trading as an investor or a business.
Provided you’re an individual investor, you’ll pay Capital Gains Tax on profits from futures trades. So your tax liability only arises at the point you close a position, not the point you open a position. Liquidation is also considered a disposal and therefore taxable event. If you’re trading regulated crypto futures in particular, there are some beneficial tax rules for US investors. You can learn more about crypto futures tax in our US Crypto Tax Guide too.
Your frequently asked questions...
What are perpetual futures?
Perpetual futures (also known as swaps) are a sub-category of derivatives. Like conventional futures, perpetual futures let investors speculate on the value of an underlying asset at a given asset, but unlike conventional futures, there is no expiration date in the contract.
Are there other crypto futures?
Yes. Bitcoin isn’t the only crypto in futures contracts. Ethereum is another common crypto featured in futures contracts. There are also many stablecoin futures contracts, and indeed, many contracts opt to settle in stablecoins like UDST or USDC rather than fiat currencies.
What’s the difference between crypto futures and crypto options?
The main difference between crypto futures and options is that with crypto futures, you’re obligated to buy/sell the underlying asset (or settle the difference), whereas with options trading, investors are not obligated to buy or sell the underlying asset. Learn more about the differences in our Bitcoin options guide.