Coin Metrics: Introduction to futures, options and other derivatives

author:Dorian kandi & amp; matías andradeSource: Coin Metrics Translation: Shan Ouba, Bit Chain Vision Realm

Key points:

Derivatives allow indirect contact with cryptocurrencies
Der derivatives allow investors to hedge down the risk of downside
Derivatives can realize a diversified trading strategy that only spot transactions cannot be realized
Derivatives allow investors to use the market inefficiently through arbitrage.

Introduction to derivatives

Derivatives are financial instruments and have become the cornerstone of the financial ecosystem, enabling participants to effectively manage risks and make the market operate more effectively.The global derivatives market is huge, and it has even made the global stock and the bond market.Similarly, derivatives in the cryptocurrency market have developed into a complicated tool for traders and investors, providing various hedging, speculative and risk management strategies for this growing asset category.The main types of cryptocurrency derivatives are futures, sustainable futures and options, and each type meets different needs.

This article deeply studies the derivatives in the traditional financial and encrypted asset markets, and study their types, applications, and basic data.

What is derivatives?

Derivatives are a financial tool that depends on the value of one or more basic variables.Traditionally, these target assets are trading assets such as stocks, bonds, currency, as well as commodities such as gold, oil and wheat.For encrypted derivatives, the value of these financial instruments is derived from the price of cryptocurrencies, such as BTC or ETH.

Derivative

Futures contract is an agreement to buy and sell assets at a scheduled price at a certain time in the future.These contracts are standardized and traded on the exchange.Futures allow traders to speculate that the future price or hedge price of cryptocurrencies fluctuates.Traditional futures have a expiration date, and the contract will be settled at that time.

Sustainable futures are similar to standard futures, but there is no expiration date.This means that traders can hold their positions indefinitely, but they must comply with the requirements of maintaining margin.Sustainable futures are usually traded in margin, allowing leverage, and affected by financing interest rates. The financing interest rate is regular payment between bulls and short positions.These interest rates make the price of the contract close to the price of the target asset.

The options give the holder the right to purchase (bullish options) or sell (seeing the options) assets at a specific price before or at the expiration of the contract, but there is no obligation.Options can be used for hedging or speculative.For example, the bullish option allows traders to benefit from rising prices, and at the same time limit down risk, because if the assets fall below the execution price, they are not obliged to buy assets.

The first diagram illustrates the return of buying and selling hedging options.Look upOptionsThe holder gives the holder the right to purchase assets at a specified price (execution price) before a certain date.

Buy viewing options (blue line): If the stock price at the time of maturity is lower than the execution price, the text is not worthy at the expiration of the options, resulting in losses limited to the rights paid.When the stock price rises above the exercise price, the income increases linearly.
Selling to watch options (green line): If the stock price remains lower than the execution price, the seller earns money through the rights received.However, if the stock price exceeds the execution price, the seller may face unlimited losses.

The second diagram shows the return of buying and selling the options.DegradationOptionsThe rights of the holder will sell assets at a specific price before a specific date.

Buy to see the options (red line): If the stock price is higher than the execution price at the maturity, the text is not worthy when the option expires, and the loss is limited to the right to pay.If the stock price falls below the execution price, the income will increase linearly.
Selling to see options (purple line): If the stock price remains on the execution price, the seller will profit through the rights received.Instead, if the stock price falls below the execution price, the seller’s loss will increase.

Traders often combine options, futures and spot tools to adjust their risk exposure and effectively manage risks.For example, miners can use futures to lock the sales price and purchase options to hedge the unfavorable price change.

Forward -looking indicator

In terms of design,Derivatives have forward -looking expectations for future events.The ratio of futures price to its basic spot price is called implicit long -term interest rate (also known as “implicit yield” or “base difference”).This implied yield is very useful for the return and expectations of different assets.When the implicit yield is positive, it indicates that the value of investors’s expected assets will increase within the contract period.Instead, negative yields indicate that investors expect the value of assets to decline.

The figure below illustrates this phenomenon.This shows a monthly period of annualized futures.The significant peaks and valleys reveal the key opinions on market expectations, and the peak value of implicit yields usually occur before the expected event.From December 2023 to January 2024, the expectations and launch of Bitcoin spot ETF coincided with a significant increase in it.With the development of market digestion, the yield rose to normalize.Another peak appeared in April, which may be driven by the expectations of the fourth half of the Bitcoin. This is a periodic event that usually attracts more attention to the asset.On the contrary, with the development of the rapid collapse of the FTX, a significant suddenly declined at the end of 2022, which had a wide impact on the encrypted asset industry.

Use cases of derivatives in tradfi

More than 20 years ago, Southwest Airlines launched the famous aviation fuel hedging plan in 1994.During the global financial crisis, the airline effectively hedged 70% of the fuel demand at a price of $ 51 per barrel; while the price of the crude oil market soared to $ 130.

It is hoped that farmers who ensure prices before harvesting can achieve this goal by purchasing agricultural derivatives.For example, corn producers may decide to sell corn futures contracts in May and settle in December.Due to the fluctuation of the corn market price, any income/loss of the corn market price will be offset by the income/loss of futures contracts.This allows farmers to cope with the risks brought by the decline in corn prices throughout the season.

Usage of cryptocurrency derivatives

One of the key cases of cryptocurrency derivatives is hedging, especially for miners.For example, Bitcoin miners invested a lot of funds in hardware and operating costs, which made them highly sensitive to the price fluctuations of cryptocurrencies.They essentially do more BTCs and short -term US dollars, because they get the mining rewards of BTC and all costs are paid in US dollars (assuming they live in the United States).By using futures or options, miners can lock the price of cryptocurrencies they mining to ensure predictable revenue sources and prevent potential prices from falling.

In addition to miners, derivatives are also useful for investors and traders in the crypto asset market.The following figure can observe their popularity. The chart illustrates the share of Bitcoin transactions in the futures market and the spot market over time.

Although spot transactions were initially dominated, futures transactions accounted for most market activities -currently 78%.This is mainly due to factors such as the strong infrastructure of centralized exchanges, the tools provided by the decentralized exchange, the more clear and attractiveness of the leverage provided by the decentralized exchanges.As the market adapts to new investment tools and launches the current Bitcoin ETF, the ratio between the spot market and the futures market will continue to change.

The rise in the level of Bitcoin Futures for each exchange further proves the role of derivatives, especially during the launch of Bitcoin spot ETF.Futures unsupering contracts refer to the value of futures contracts that have not yet been settled or liquidated, as a measure of market activities.The BTC unclear contract reaches 30B US dollars may be because investors may purchase spot Bitcoin ETF and hedge the risk of hedging through futures contracts.This highlights an important case of derivativesBecause they allow investors to manage risks and strategically locate themselves in the market.

The settlement mechanism of derivatives is crucial.In the traditional market, derivatives can be settled in cash or physical settlement.Cash settlement derivatives are based on the difference between the contract price and the market price during the settlement and settle in cash.The derivatives of physical settlement involve the actual delivery of assets.Most cryptocurrency derivatives, especially derivatives such as CME, are settled in cash.This means that during the settlement, the participants exchanged value differences rather than actual cryptocurrencies.

in conclusion

Derivatives in the cryptocurrency market have become important tools for management risks and enhanced trading strategies, reflecting their importance in traditional finance.They enable participants to hedge price changes, speculate on future prices, and get the leverage of cryptocurrencies. At the same time, they usually settle in cash to promote easier transactions and settlement processes.The development of encrypted derivatives has greatly promoted the maturity of the digital asset ecosystem, providing familiar tools for institutions and retail investors to control this new asset category.