Savvy investors use futures to hedge the risks of a potential drawdown in their portfolio. How it happens in practice and what is the difficulty of working with this financial instrument
Since the beginning of May, investors have the opportunity to trade futures at 1 / 10th of the value of bitcoin. This financial instrument was launched by the Chicago Mercantile Exchange CME Group, which added Bitcoin futures in 2017. Ethereum futures appeared on CME in February 2021. It became the first altcoin traded on the American stock exchange.
What is futures
A futures contract is a contract that guarantees that a buyer buys an asset at a specified time, in a specified amount, at a predetermined price. These contracts can be traded and guarantee the execution of the trade.
Futures contracts allow traders, investors and manufacturers of goods to speculate on the future price of an asset, that is, traders trade bitcoin at the future price, which is agreed upon at the time of signing the contract, explained Sergey Zhdanov, COO of the EXMO exchange. Using futures, you can resort to using leverage – borrowed funds that increase the volume of buying or selling an asset, thereby increasing the volume of potential profits or losses, added Viktor Pershikov, lead analyst at 8848 Invest.
Practical use
Futures can be used as a trading instrument to hedge risks, the analyst said. To do this, it is necessary to sell futures for the amount of the cryptocurrency portfolio in order to neutralize the risk of its possible drawdown, advises Viktor Pershikov. According to him, the financial results from the sale of the futures will cover the loss from the portfolio decline. Analyst 8848 Invest does not recommend using futures as an independent and only tool for making money.
“Attempts to buy and sell futures while trading actively often make less sense than a well-formed investment portfolio hedged by futures,” he explained.
Risks and difficulties
Futures are a complex financial instrument, warns Sergei Zhdanov, who does not recommend using such contracts for beginners. According to him, it is necessary to understand that in order to make a profit, you need to buy an asset on the spot market and sell the corresponding futures. The trader will only benefit if the prices of the futures and the spot get closer, explained the chief operating officer of the EXMO exchange.
“You need to understand that short is always a non-interest-bearing loan from the exchange, which undoubtedly affects the final profit figure,” he added.
When trading futures, a trader must balance between the desire to make money and the understanding of the need to fix losses at predetermined levels, said Viktor Pershikov. At the same time, the cryptocurrency market, unlike classical markets, is more deeply corrective, therefore, the frequent departure of the price against the futures trader with a loss at the beginning, and the subsequent movement in the expected direction is a very frequent picture, the analyst explained.