Bitcoin perpetual contract formula

The perpetual contract formula, Index Price × (1- Funding Rate), determines the settlement price when traders roll over or liquidate their Bitcoin positions.

Oct 31, 2024 at 06:05 pm

Bitcoin Perpetual Contract Formula

1. Understanding Perpetual Contracts

• Perpetual contracts are futures-like instruments that allow traders to speculate on the price of an underlying asset (e.g., Bitcoin) without a fixed expiry date.
• Traders can hold positions indefinitely by rolling over their contracts each funding period.

2. Perpetual Contract Formula

The perpetual contract formula determines the settlement price at which a position is closed when it is rolled over or liquidated. It is calculated as follows:

Settlement Price = Index Price * (1 - Funding Rate)

Where:

• Index Price: The current market price of the underlying asset
• Funding Rate: A variable rate that is applied to traders' positions periodically to maintain market parity with the underlying asset

3. Funding Rate

The funding rate is calculated based on the difference between the perpetual contract price and the index price:

• If the perpetual contract price is higher than the index price (contango), the funding rate is positive, and short positions (positions betting on a price decrease) pay long positions.
• If the perpetual contract price is lower than the index price (backwardation), the funding rate is negative, and long positions pay short positions.

4. Practical Example

Suppose the current Bitcoin price is $30,000 and the perpetual contract price is $29,950 (contango market). Let's say the funding rate is 0.01%.

• If a trader holds a short position, they will pay a daily funding fee of $0.30 (0.01% × $30,000).
• If a trader holds a long position, they will receive $0.30 in funding each day.

5. Trading Implications

• Contango: Traders should be cautious about holding short positions in a contango market as they will incur increasing fees over time.
• Backwardation: Traders may benefit from holding long positions in a backwardation market as they will receive funding payments.
• Arbitrage Opportunities: The difference between the perpetual contract price and the index price can create arbitrage opportunities for traders who can execute trades between the two markets to exploit market inefficiencies.