Differences Between Perpetual Contract and Traditional Futures Contract
A Perpetual Contract in futures trading is similar to a traditional Futures Contract, with the key difference being that there is no expiration or settlement of the contract.
Let's take an example of a traditional Futures Contract for a physical commodity like wheat or gold. These contracts require delivery of the commodity when the futures contract expires, resulting in carrying costs for the contract.
The price for the commodity may also vary depending on the time between the current period and the future settlement time for the contract. As this gap widens, the contract's carrying costs increase, and the potential price gap between the Spot and traditional Futures markets grows larger, leading to greater uncertainty.
A Perpetual Contract attempts to mitigate these issues by not requiring the delivery of the underlying commodity and mimicking the behavior of the Spot market. This helps reduce the price gap between the Futures Price and the Mark Price, resulting in a more accurate representation of the actual market value. This is a significant improvement compared to traditional Futures Contracts, which can have prolonged or even permanent differences versus the Spot Price.
Understanding Perpetual Contracts
Perpetual contracts are derivative products that enable traders to speculate on the future price movements of cryptocurrencies without owning the underlying asset. These contracts are perpetual in nature, meaning that there is no expiration date, and traders can hold their positions indefinitely.
Key Concepts to Know
To trade perpetual contracts effectively, traders should have a solid understanding of the following key concepts:
Mark Price
Mark price is used to calculate the unrealized profit and loss for traders and to prevent market manipulation. It is determined based on the spot price of the underlying cryptocurrency and takes into account factors such as trading volume and liquidity.
Initial and Maintenance Margin
To enter into a perpetual contract, traders must provide an initial margin, which is a percentage of the notional value of the contract. Maintenance margin refers to the minimum margin required to keep a position open. If the margin level falls below the maintenance margin, the position may be automatically liquidated.
Funding
Funding is a mechanism used in perpetual contracts to ensure that the contract price converges to the mark price over time. It is essentially a transfer of value between long and short positions in the market, with the rate being determined by supply and demand.
Risk
Trading perpetual contracts involves risk, particularly in terms of margin trading. Traders can place orders that exceed their initial collateral, known as "leveraging," which amplifies both profits and losses. Therefore, it is crucial for traders to manage their risk effectively and have a solid understanding of leverage.