If you’ve been following the previous few issues of SIMETRI Edge, you know that I aim to make derivatives less intimidating. This should help you enhance your portfolio management skills, not set you up for day trading.

Let’s start diving into futures and how they can be useful for a crypto investor. Today, I’ll give you a high-level overview of the subject. Then, in the following emails, we’ll review possible usage scenarios, and I’ll show you how to trade futures on-chain. Let’s dive in.

Futures and Leverage

Let’s start with a quick refresher about what futures contracts are. In simple terms, futures contracts provide rights to buy or sell some asset at a predefined price at some point in the future.

The easiest example is a farmer hedging the risk of his product declining in value by selling a futures contract to a factory. If his product gets cheaper over time, he won’t suffer from it. Conversely, he will lose some extra profits if the price increases.

There’s value in the physical delivery of a product to the factory in the example above. But, you don’t necessarily benefit from this when it comes to speculative assets. Does it mean that stocks and crypto futures are useless? No, because they provide access to leverage.

Leverage is often associated with individuals or even countries going into deep trouble. While in many cases leverage caused or enhanced negative outcomes, it’s not because it’s bad on its own. It sounds wild, but avoiding leverage can increase risk, and introducing it can decrease risk if used correctly. 

If you think about it, it’s natural that concentrating funds in one asset and levering the position up is a recipe for disaster. However, using leverage on multiple small bets can enhance one’s portfolio’s performance.

Institutional investors very well recognize the risks and advantages of leverage in investing. I suggest we would only benefit from being good remoras and following their example.

You, riding on the back of a big institutional investor.

Now that you know what futures are and why you might dabble into them let’s review possible scenarios where they can come in handy.

Delta-Neutral Farming

Delta-neutral means that the value of your position remains the same in dollar terms even if the asset you hold is volatile. How is that possible, and why is it needed? 

Crypto is famous for high percentage yields. However, you have to provide two assets to access these yields and potentially suffer from impermanent loss. 

You can use futures contracts to short the volatile asset in question to mitigate that. So, if the price declines, you will cover up your impermanent loss with the profit from the short position. 

There still may be a loss due to how strategies like this work, but it would only come if the asset in question declines or grows by a lot.

Profit/loss chart of a delta-neutral farming strategy on a levered BNB-BUSD pair.

Hedging

Let’s say you have a couple of long-term holds that you plan to stick to for another 3-5 years. However, during the next bull-run, their prices over-extended. 

You don’t want to sell to fix the gains because it’s too early for your investment horizon. Yet, you feel like the market is overheated, and a correction is due. In this case, you may use some money to short the asset in question. 

Note that you didn’t touch your spot holdings and used a small amount of money for hedging purposes. If you’re wrong, you still have your high-conviction bet that’s growing in value. If you’re right, you don’t give up the gains you’ve made so far.

Boosting

I don’t want to mislead you with this one, but I think you should know about it. You can boost your returns if you have a high-conviction bet on some asset and believe that the market is up-trending.

You can open a leveraged long position with some non-significant money on the asset you like. You will get a higher premium on your conviction if you’re right. However, if you’re wrong, the amount you lost shouldn’t make you nervous.

Next time, we’ll look at where you can practice futures trading without putting real money on the line. Have a good day.

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Disclosure: At the time of writing, the author held ETH and several other cryptocurrencies. Read our trading policy to see how SIMETRI protects its members against insider trading.