If you’re starting to explore the world of cryptocurrency trading, you might have heard the term futures contracts, and wonder how they work. If you’re familiar with traditional stock market futures, you have an advantage. Even if you know nothing about these interesting ways of buying and selling cryptocurrency, you need only master a few basic facts.
Futures are one kind of derivative, meaning that you aren’t really exchanging the currency itself when you make a deal. You’re entering into a contract to exchange some fixed amount of a particular currency, Bitcoin (BTC) for example, for another currency, USD for example, at a specific date in the future. This forward-looking perspective of the contract is what gives it its name. If you’re currently learning how to trade cryptocurrency, before delving into the fast-moving world of crypto derivatives you should make note of the following key points.
Several major US exchanges now allow futures trades in Bitcoin and other cryptocurrencies. Until recently, individuals were not able to do this on any major securities floors in the US. What does that mean for people who enjoy putting their money at risk in the hopes of making a profit on price changes in Bitcoin? It means they have a place to enter into sanctioned, legal contracts that will be fully liquidated at expiration. Payout if guaranteed and there will always be plenty of buyers and sellers.
You Don’t Have to Hold the Primary Asset
Future-based contracts do not require participants to own anything. In other words, you can go on the Chicago Board Options Exchange (CBOE) and purchase any number of Bitcoin futures contracts without buying any BTC at all. At expiration, your contract will be worth more, less, or the same as when you bought it, dictating whether you made a profit, sustained a loss, or broke even. Note that when you buy into the deal, you have to put up whatever the current price is for BTC on the spot market at that moment, plus a transaction fee and brokerage fee.
Two Ways to Go
There are two basic strategies you can employ, and they’re exactly the same as in the traditional stock market. You go long or go short. Going long means you believe the price of the underlying asset, BTC in this case, will rise. Alternatively, you’ll want to go short if you think the price of BTC will take a dive. One reason these exchanges are so popular and active is because virtual currencies, unlike most stocks, have a tendency to fluctuate in price a great deal. Guess right and you stand to make a profit. Guess wrong and you go into the red, however. So make sure you follow risk management best practices at all times.
When Does It End?
You can choose to sell your position any time before the expiration date. When you engage in these kinds of transactions, note carefully the specific calendar date after which you won’t be able to amend or extend the agreement. Once that date arrives, you’ll be forced to close out your position and take a profit or loss. Up until then, you were free to opt out at any time. This flexibility is one of the reasons the CBOE has seen a lot of interest in cryptocurrency activity.