Arbitrage opportunities between the Spot & Futures markets
We exploit inefficiencies between the Spot & Futures market to yield low-risk returns. We'll show you how we do this at scale, but first, let's explore the fundamentals of perpetual futures contracts.
What are Perpetual Futures Contracts?
Unlike traditional futures, perpetual futures contracts don't have an expiration date so traders can trade perpetual futures just like spot trading. That's one of the main reason perpetual futures contracts is so prevalent in the crypto community.
Typically, traditional futures contracts settle on a monthly or quarterly basis. The contract price converges with the spot price at settlement, and all open positions expire.
Since perpetual futures contracts never settle in the traditional sense, exchanges need a mechanism to ensure that futures prices and index prices converge regularly. This mechanism is also known as Funding Rate.
The funding rate plays an essential role in the arbitrage opportunity that we will discuss in the next section.
What is the Funding Rate
The funding rate ensures that futures prices and index prices converge regularly.
So when a perpetual futures contract is trading on a premium (higher than the spot markets), long positions have to pay short due to a positive funding rate. In contrast, short positions pay longs while the futures price is trading below the index price. The Index Price consists of the average cost of an asset, according to significant spot markets and their relative trading volume.
The exchanges do not charge the funding fee. It's paid peer-to-peer.
Most of the investors in the crypto market like to hold a long position rather than a short position, which means traders with long positions need to pay funding rates to those who have a short position.
So here's the arbitrage opportunity. We can hold a short position in the perpetual futures market and buy the same amount in the spot market, hedging our total investment. Our investment won't be affected by the market fluctuation due to the market-neutral position but will receive funding rates with our short position in the perpetual futures contracts.
Crypto Arbitrage shops around at various Crypto future providers to identify the highest funding rates by scanning each asset pairing available on the respective futures market.
What is Spot-Futures Arbitrage Strategy?
To sum up, hold a short position in the perpetual futures market while holding the same position in the spot market. Arbitrage with a market-neutral position and receive the funding rate every 8 hours.
The funding rate comprises two components: the interest rate and the premium. The interest rate is fixed at 0.01% per 8 hours, and the premium varies according to the price difference between the perpetual contract and mark price.
According to the historical data of the ETH funding rate on Binance, the rate has always been positive in the last six months. And it's higher when the price surge in the following chart. So if we can receive a 0.2% funding rate per day, the performance for this arbitrage would be 36.5% APR!
With the historical data, it's steady and almost risk-free to arbitrage from the funding rate.
With the historical data, it’s steady and almost risk-free to arbitrage from the funding rate.
So how does it work exactly?
Let's say we have 10000 USDT for the spot-futures arbitrage while bitcoin's price is 10000 USDT. Here's what we're going to do:
- Transfer 5000 USDT to the futures account and the rest 5000 USDT to the trading account.
- Buy 0.5 BTC (5000USDT) in the spot market and short 0.5 BTC in the perpetual futures market with your 5000 USDT
- If the current funding rate is 0.05% right before the charges, then you'll get 2.5 USDT.
- 0.5 * 10000 * 0.05% = 2.5 USDT
- If the funding rate remains at 0.05%, we can receive three times a day, which means it's risk-free 0.15% profit per day.
How long do we run a spot futures arbitrage trade?
We run the arbitrage trade for as long as the funding rate stays positive. As soon as it goes negative, our software immediately closes our positions in the Spot and Futures market; at this point, an arbitrage trade is published in our admin dashboard. After that, our clients will receive a breakdown of the completed arbitrage trade and their respective profits.
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