Futures Spread Trading

So what is futures spread trading?

Cryptocurrency futures spread trading is type of market-neutral strategy where the investors seek to profit from the change in the price differences - the spread price - between two positions - short and long - on the two futures contracts on the same asset with different delivery dates, or on the two futures contracts on different assets that are price correlated to each other with the same delivery date.

What is spread?

Spread is price difference between two futures contracts. This difference is not constant and depends on couple of factors (to which we will come back later)

The price of a futures contract will be equal to the spot price plus the cost incurred in carrying the asset till the maturity date of the futures contract. The Carry Cost refers to the cost of holding the asset till the futures contract matures.

The price of the each futures contract is formed by the market based on the market participants' expectations/calculations of the future price of the asset at the maturity date and estimated costs of carrying the asset till the maturity date. As each futures contract is traded on separate market with different liquidity, the price volatility of each contract may be different, resulting in changes of the difference between the contract prices.

chart with spread price

An example of the spread price changing through the time

Cycle of the spread trade

With the spot price trading we buy the asset when we hope that its price is going to grow, we sell it when the price has grown. In case we think the asset price is going to fall we are selling it and buying back when the price has fallen. The same is with spread trading - we buy the spread, when the spread price is low and we sell the spread when its price is high. Or if we think that current spread price is high and we think it is going to fall, we sell the spread and we buy it back when the price has fallen.

Types of spreads

Spreads can be categorized as intramarket spreads and intermarket spreads.

Intramarket spreads, also referred to as calendar spreads, involve buying a futures contract with delivery date in one month while simultaneously selling the contract on the same underlying asset with the delivery date in a different month.

Intermarket spreads involve buying a futures contract on asset A and selling the futures contract on another asset - asset B - with the same delivery dates, with the assumption that the prices of asset A and asset B are correlated.

Calendar Spreads

Calendar spread traders are primarily focused on changes in the relationship between the two contract months. The goal of this strategy is to take advantage of those changes. In most cases, there will be a loss in one leg of the spread, but a profit in the other leg. If the calendar spread is successful, the gain in the profitable leg will outweigh the loss in the losing leg.

Futures contracts delivery dates

The delivery date, also known as the settlement date or value date, refers to the specific date on which an investment contract must be completed - settled. Majority of the cryptocurrency exchanges follow the pattern known from the "traditional finance" world - they provide futures contracts with the quarterly based frequency of the delivery dates - March, June, September and December, however some of the exchanges provide more delivery dates (ie. Deribit)

EXAMPLE

Lets take for an example calendar spread on Bitcoin futures. We have two outright contracts

  • BTC-USD-30SEP23 - Bitcoin futures contract with the delivery date on 30th September 2022
  • BTC-USD-30JUN23 - Bitcoin futures contract with the delivery date on 30th June 2022

BUYING the calendar spread: BTC-USD-30SEP22 - BTC-USD-30JUN23 - means taking long position on BTC-USD-30SEP22 and short position on BTC-USD-30JUN23

SELLING the calendar spread: BTC-USD-30SEP22 - BTC-USD-30JUN23 - means taking short position on BTC-USD-30SEP22 and long position on BTC-USD-30JUN23

Minimizing the risk

By taking long position on BTC-USD-30SEP22 and short position on BTC-USD-30JUN23 we are far less exposed to the price movements of the Bitcoin! One can say - we are immune to price movements of the Bitcoin, though this is not entirely true. In case the Bitcoin price goes up, both contracts will follow. Our long BTC-USD-30SEP22 will grow enough to compensate for the loss on our short BTC-USD-30JUN23 position. Same in the opposite direction - in case the Bitcoin goes down - the profit from our short position will compensate for the loss on our long position.

In case of USD-margined futures you do not need to hold bitcoin at all - you have no exposure, you are just keeping your USDs on your margin account!

Leverage & Margin

Futures contracts are usually leveraged, the leverage on cryptocurrency exchanges varies from 20 to even 100. With the leverage equal to 100 and Bitcoin price 20k USD, you just need 200 USD to buy or short-sell one bitcoin. Even though single spread trading cycle (buying the spread and the selling it) provides smaller profit than what outright traders may expect, but with the leverage in place you can multiply it many times.

In case both legs of the spread are on the same exchange, some exchanges detect the calendar spread and decrease margin requirements even further - that increases your capital efficiency even further.

Trading Fees

There are two methods of executing spread trades: with market orders and with limit orders.

Executing the spreaed trade with MARKET orders: when executing single spread trade - ie. buying the spread, we are in fact performing two transactions on the exchange - two market orders. The average fee for a single market order is 0.05% of the transaction amount. In case we trade on 1 bitcoin, worth 20000 USD, the fee for opening one outright contract with the market order is 10 dollars. The fee for buying the spread is 20 dollars. Going further down this street - selling the spread costs another 20 dollars. Total fees in full spread trade cycle is 40 dollars. One can easily figure out that in order for the spread trade cycle be profitable, the change in the spread price must be higher than 40$.

Executing the spreaed trade with LIMIT orders: this method is much more complex and deserves separate article. In full cycle we execute two limit orders and two market orders. Fee for limit orders is usually 0. That brings down the total fees for the full spread trade cycle to 20$.

EXAMPLE of the positive profit spread trading

In this example we will analyse theoretical trade on the calendar spread: BTC-USD-30SEP22 - BTC-USD-31MAR23. We will analyze the price of individual outright contracts as well as the price of the spread. The full cycle of this spread trade will be almost 30 days - starting at 6th June 2022, ending on 3rd July 2022. For both days we will asume the price at the closing value of the daily candle. The same idea may be executed in much shorter time frame. So let's take a look at the prices of our outright contracts at

BTC-USD-30SEP22 on 6th June 2022:

chart with spread price


BTC-USD-31MAR3 on 6th June 2022:

chart with spread price


To sum up, on 6th June we have:

  • BTC-USD-30SEP22 with price 31676 USD
  • BTC-USD-31MAR23 with price 32225 USD

The spread BTC-USD-30SEP22 - BTC-USD-31MAR23 on 6th June is -549 USD. Don't worry about the negative number - this is normal with spreads. What is important - it needs to grow ;).

Let's get down to the details a little bit - we need to open two positions and we need to pay a fee for opening each of them. In this scenario we will be using market orders in order to open and close the outright contracts. Let's assume fee equal to 0,05% for market orders. Let's do the math. We will open two positions, each with size of 1 Bitcoin

  • Outright 1(Long): +1 BTC-USD-30SEP22: price 31676 USD -> resulting fee: 15.83 USD
  • Outright 2(Short): -1 BTC-USD-31MAR23: price 32225 USD -> resulting fee: 16.11 USD

Let's check our margin requirements - assuming the leverage 50x we need around 640 USD for each of the positions. In total we need 1280 USD on our margin.

Now let's shift a bit in time to 3rd July 2022BTC-USD-30SEP22 on 3rd July 2022:

chart with spread price


BTC-USD-31MAR3 on 3rd July 2022:

chart with spread price


To sum up, on 3rd July we have:

  • BTC-USD-30SEP22 with price 19159 USD
  • BTC-USD-31MAR23 with price 19313 USD

The spread BTC-USD-30SEP22 - BTC-USD-31MAR23 on 6th June is -154 USD

Let's assume we've closed our positions on 3rd July and let's check what are the fees:
  • Outright 1(Short): -1 BTC-USD-30SEP22: price 19159 USD -> resulting fee: 9.57 USD
  • Outright 2(Long): +1 BTC-USD-31MAR23: price 19313 USD -> resulting fee: 9.65 USD

Now let's calculate our PnL (Profit and Loss). Let's take a look what has happened with our individual positions on individual outright contracts:

  • +1 BTC-USD-30SEP22, open price 31676 USD, close price 19159 USD -> resulting PnL: -12517 USD
  • -1 BTC-USD-31MAR23, with price 32225 USD, close price 19313 USD -> resulting PnL: +12912 USD

The PnL is equal to 395 USD. Total fees were 51,16 USD. The net PnL - after including fees - 343.84 USD. In case we wanted to calculate our ROI (Return on Investment) - we need to divide our PnL by the funds engaged - let's go and let's do that:

PnL = 343.84 USD, funds engaged = 1280 USD, RoI = 26,86% - not that bad if we take under account that we were not exposed for the Bitcoin price risk.

Caveats
1. In this analysis the hidden catch is with the margin - as the outright contracts price has changed so dramatically, in case you would open positions on two different exchanges, you would have to have much bigger margin to cover for the price change of your long BTC-USD-30SEP22 contract.

2. The charts I've used are from Deribit that has coin-margined futures - that means that margin would have to be held in Bitcoin and up to the size of the margin - 1280 USD initially - we would be exposed to the fundamental risk of posessing Bitcoin. But the example could as well be executed on any other exchange that has USD-margined futures (ie. Binance)