What is a Futures Contract?
A futures contract allows you to purchase or sell a commodity or currency at a specified price at a future date.
The futures market is different from the spot market in that transactions are settled on a daily basis. Instead, the counterparties will trade the futures contract that determines settlement. The futures market is not able to allow users to buy or sell digital assets or commodities. They trade the representations in the contract. Actual trading of assets or cash will take place in the future, once the contract has been executed.
Consider the simple case of a futures agreement for physical commodities such as gold or wheat. These contracts can be labeled for delivery in some traditional futures markets. This means that the commodity will be delivered to you. Gold and wheat must be transported and stored, which can lead to additional costs, known as storage costs. Many futures markets have cash settlement. This means that settlements are made at an equivalent monetary value to the goods.
Depending on the date of contract execution, the futures price for gold and wheat may vary. The greater the storage cost, the more uncertain future prices will be and the wider the price gap between futures and spot markets, the larger the time gap.
Why do users trade futures contracts?
- Hedging and risk management were the key reasons for the invention futures.
- Short Position: Traders may place bets on the performance of assets, even if they don’t have them.
- Leverage: Trader can open positions larger than their current account balance. You can trade perpetual futures contracts on Binance with leverage as high as 125x.
What is a perpetual forwards contract?
An open-ended futures contract is a unique type of futures contract. However, unlike traditional futures contracts, it doesn’t have an expiration date. You can keep the position for as long as your heart desires. Trading in perpetual contracts, however, is dependent on the index’s base price. The index price is the average asset price according to major spot markets and their relative trading volumes.
Perpetual contracts, unlike regular futures are traded at a price that is very close to spot market prices. In extreme market conditions, however, the brand’s price may differ from the spot market price. The settlement date is what makes traditional futures different from open-ended contracts.
What is the initial margin
The initial margin is the minimum amount that you must pay in order to open a position using leverage. With a 100 BNB initial margin (with 10x leverage), you could buy 1000 BNB. Your initial margin will equal 10% of your total order amount. Your initial margin acts as a pledge and helps you maintain your leveraged position.
What is the maintenance margin?
The minimum amount of collateral that you need to keep trading positions open is maintained margin. You will be asked to deposit additional funds or liquidated if your margin balance drops below this level. The majority of cryptocurrency exchanges do the former.
The initial margin is the amount you set when you open a new position. The supporting margin is the minimum balance you need to keep the positions open. The maintained margin (or maintained margin) is a dynamic value which changes according to the market price and your balance (margin).
What is liquidation?
Your futures account could be liquidated if the value of your collateral drops below the maintained margin. Binance liquidation can take place in different ways depending on the risk and leverage each user takes (based on their collateral exposure and risk exposure). The required margin is higher for larger positions.
Binance charges 0.5% of its nominal commission to liquidate the first level (net risk less than 500,000 US dollars). The user is refunded any remaining funds if there are additional funds on the account after liquidation. If the amount is less than this, the user will be declared bankrupt.
You will be charged additional fees for liquidation. You can avoid this by closing your positions prior to the liquidation price being reached or adding additional funds to your collateral balance. This will further deviate from the current market prices.
What is the financing rate
Finance is a regular payment between buyers and sellers based on the current financing rate. If the financing rate is higher than zero (positive), contract buyers (trading traders) must pay those with shorter positions (contract sellers). A negative funding rate, on the other hand, means that long positions are paid for by short ones.
The interest rate and premium are the two main components of the financing rate. The interest rate in Binance’s futures market is 0.03%. The premium fluctuates depending on the spot and futures prices. Betting transfers between users are free and Binance doesn’t charge any fees.
If an open-ended futures contract trades at a premium (higher that in spot markets), then long positions should be covered by short positions because of a positive funding rate. This will likely result in a drop in price as long positions are closed and new ones opened.
What is the cost of the brand?
The labeling price represents an estimate of the contract’s true value (fair price) and its trading price (last prices). The brand price is used to prevent unfair liquidation. This can happen when the market’s volatility is high.
The index price is a function of spot market prices, but the labeling price represents fair value for a perpetual futures contract. The price mark on Binance is based upon the index price and financing rate. It is an important part in the calculation of unrealized PnL.
What is the purpose of PnL?
PnL is profit or loss. They can either be realized or not. Your PnL, if you have open positions on the perpetual futures market is not realized. This means that it is still changing to meet market movements. The unrealized PnL is converted to the implemented PnL when you close your positions.
Realized PnL is the profit or loss that results from closed positions. It does not relate to the mark price but to the executed price. Unrealized PnL, on the other hand is subject to constant change and can be a significant factor in liquidation. To ensure fair and accurate calculation of unrealized PnL, the stamp price is used.
What is an insurance company?
An insurance fund, in simple terms, is an insurance policy that prevents the balances of losing traders from dropping below zero. It also guarantees that winning traders will make their profits.
Let’s say Alice has $2,000 in her Binance Futures account. This is used to open a 10xBNB long position at $20 per coin. Notice that Alice does not buy contracts from Binance, but another trader. On the other side, Bob has a short position of approximately the same size.
Alice has a position worth 1,000 BNB, which is $20,000 with a margin $2,000. This leverage of 10x allows Alice to hold a position of $1,000 BNB (worth $20,000). Alice may lose her position if BNB prices drop from $20 to $18. This will result in Alice’s assets being liquidated and her $2,000 collateral going bankrupt.
The Insurance Fund will be activated to protect the losses of the system if it is unable close its positions in time or the market price drops further. Alice’s balance will remain unchanged since she was liquidated. However, this Insurance Fund will ensure Bob is able to maximize his profits. Alice’s balance sheet without the Insurance Fund would fall from $2,000 down to zero and could even turn negative.
In practice, however, it is likely that its long position will be closed before then, as its maintenance margin will fall below the minimum. The Insurance Fund receives the liquidation fees, while the rest of the funds are returned to the users.
The Insurance Fund was created to protect bankrupts’ accounts from losses by using collateral taken from liquidated traders. The Insurance Fund should grow steadily under normal market conditions as users are eliminated.
The insurance fund’s value increases when users are liquidated before they reach break-even or a negative value. In extreme cases, however, the system might not close all positions and the Insurance Fund may be used to compensate for losses. This can happen during periods of high volatility and low market liquidity, although it is uncommon.
What is automatic deleveraging?
Auto-deleveriding is the process of liquidating a counterparty. This happens only when the Insurance Fund stops working (in some situations). It is unlikely that profitable traders will be required to pay a portion of their profits in order to compensate for the losses of losing traders, but it is possible. It is difficult to avoid the possibility due to the volatility in cryptocurrency markets and high leverage offered clients.
The Insurance Fund is unable to cover all bankrupts’ positions, so the final step is liquidation of the counterparty. Positions with the highest profit margins (and leverage) usually bring more. Binance uses an indicator to tell users where they stand in the queue.
The Binance Futures Market system tries to avoid automatic deleveraging and has many features to minimize its impact. In the event of this happening, liquidation of the counterparty takes place without market fees. A notice is sent to affected traders immediately. Users have the ability to re-enter positions at anytime.