Profiting From Bitcoin Derivatives: A Beginner's Guide

Bitcoin derivatives are financial contracts that derive their value from Bitcoin. They allow investors to speculate on the price movement of Bitcoin without actually owning it. Crypto derivatives are complex and best suited for advanced traders as they can be very risky. There are three main types of derivatives: futures, options, and perpetual swaps or perpetual contracts. Crypto derivatives can be traded on exchanges such as Binance, Huobi Global, ByBit, OKEx, and Bitmex.

Bitcoin derivatives exchanges

Derivatives exchanges are legal and regulated marketplaces for trading derivatives such as options, futures, and swaps. They are platforms where buyers and sellers can trade using standardised instruments and in accordance with defined rules and regulations. Crypto derivatives exchanges are online platforms that facilitate open-source peer-to-peer (P2P) decentralised cryptocurrency trading.

Crypto derivatives exchanges are a relatively new concept in blockchain and have recently gained significant traction. They allow traders to create prediction markets and speculate on the price movements of any crypto asset without actually having to purchase the asset. This means they do not need to take ownership of the underlying asset or account.

There are multiple use cases for a derivatives exchange, such as hedging risk or creating a synthetic long/short position. Crypto derivatives are derived from the value of a cryptocurrency or bundle of cryptocurrencies. They can be traded via an exchange, much like stocks or commodities. The exchange typically holds investor assets in escrow until a derivative contract has been fulfilled.

The top crypto derivatives exchanges include Binance, Huobi Global, ByBit, OKEx, and Bitmex. The biggest crypto derivatives exchange is Binance. Bybit is another popular option, dedicated solely to derivatives markets. Phemex is also a popular choice, as it allows leverage of up to 100x, and does not require KYC.

How to trade Bitcoin futures

Bitcoin futures are a type of derivative contract that allows investors to speculate on the future price of Bitcoin without actually buying or selling the cryptocurrency itself. Trading Bitcoin futures involves agreeing to buy or sell Bitcoin at a predetermined price on a future date. This can be a useful way for investors to gain exposure to Bitcoin without having to hold the underlying asset.

• Understand the Risks: Before investing in Bitcoin futures, it is important to understand the risks involved. Bitcoin is a highly volatile and risky asset, and trading derivatives can be complex. Consider consulting a financial advisor to assess whether this type of investment is suitable for your portfolio and risk tolerance.
• Choose a Brokerage Platform: Select a brokerage platform that offers Bitcoin futures trading, such as tastytrade, CME Group, or specific brokers like FOREX, TD Ameritrade, or Interactive Brokers. Ensure that the platform is regulated and provides the necessary tools and resources for trading.
• Open an Account: Sign up for an account with your chosen brokerage platform. You may need to provide personal information and financial details to complete the account opening process.
• Fund Your Account: To start trading Bitcoin futures, you will need to deposit funds into your account. Different platforms may have different minimum deposit requirements, so make sure to review their funding guidelines.
• Conduct Research and Create a Trading Plan: Before placing any trades, it is crucial to conduct thorough research and analysis. Study the Bitcoin market, including price history, trends, and news that may impact the cryptocurrency's value. Develop a trading strategy that outlines your entry and exit points, risk management techniques, and investment goals.
• Place Your Trades: Once you are set up on your chosen platform and have a clear trading plan, you can start trading Bitcoin futures. Remember to adhere to your trading strategy and practice disciplined risk management to help minimize potential losses.
• Monitor and Manage Your Positions: After entering the market, regularly monitor your open positions. Depending on market movements and your trading strategy, you may choose to hold or close your positions before the contract expiration date. You can also use tools like stop-loss orders to limit potential losses.
• Understand the Settlement Process: Bitcoin futures contracts typically settle in cash, meaning you receive the cash equivalent of the Bitcoin price at the specified date, rather than the Bitcoin itself. Understand the settlement process and whether you can choose to settle in cash or roll forward your contract to extend it.

Remember that trading Bitcoin futures carries significant risks, and it is not suitable for beginners. Ensure that you have a comprehensive understanding of the market, strong risk management strategies, and that you are complying with the regulatory requirements in your jurisdiction.

Bitcoin futures contracts

There are two positions you can take on a Bitcoin futures contract: long or short. If you take a long position, you agree to buy Bitcoin in the future at a specific price when the contract expires. When you take a short position, you agree to sell Bitcoin at a set price when the contract expires.

For example, if you own one Bitcoin priced at $18,000 and you foresee that the price will drop in the future, you can sell a Bitcoin futures contract at the current price of $18,000 to protect yourself. Close to the settlement date, the price of Bitcoin, along with the price of the Bitcoin futures contract, would have dropped. You can then buy back the Bitcoin futures contract at, for example, $16,000. This means you have made $2,000 and protected your investment by selling high and buying low.

The benefits of trading Bitcoin futures contracts include the ability to gain exposure to Bitcoin without actually owning it, the opportunity to use leverage to increase potential profits, and the ability to manage risk through hedging. However, it's important to note that leverage can also amplify losses, and the volatile nature of Bitcoin means that margin amounts required for trading its futures are generally higher than for other commodities and assets.

Perpetual contracts

When the price of a perpetual contract is higher than the spot rate, buyers of the contracts (known as longs) pay a funding fee to the sellers (known as shorts). This encourages more sellers to enter the market, bringing the price of the perpetual contract closer to the market rate. The opposite occurs when the perpetual contract trades below the underlying asset's market rate.

Traders can choose to go long or short on a perpetual contract, depending on whether they expect the price of the underlying asset to increase or decrease. Going long involves buying a perpetual contract with the expectation that the asset's value will rise in the future, while going short involves selling a contract in anticipation of a decline in value.

Bitcoin options

If you purchase a call option for BTC at a certain price that expires in a week, this means that one week later, regardless of where the price is at, you have the option to buy one BTC for that predetermined price (the price at which you can buy the asset in the future is called the strike price). If the price of BTC has risen above the strike price, you would exercise your right as you can purchase a BTC for a cheaper price and then sell it for a profit. If the price has dropped below the strike price, you would simply choose to let the option expire as purchasing a BTC at the strike price would translate to a loss.

It is important to understand that options do not offer investors a risk-free method of crypto derivatives trading. Each option has its own price, called a premium, which varies based on market conditions. So when a trader lets their option expire without exercising their right to buy or sell, they still lose whatever premium they paid for that option.

Call options allow a trader to purchase an asset on a given date, while put options allow a trader to sell an asset on a given date. In addition, American options can be sold before the contract’s expiry date, whereas European options need to be sold exactly on the agreed date.

Traders are required to pay fees to buy a contract. For example, if an option costs $800, a trader will bear this cost to enter, on top of the actual price of the asset they want to purchase. Regardless of the trade outcome, the trader must pay the fee. So, it’s worth noting that options are not a completely risk-free method of trading crypto derivatives.

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