How to calculate liquidation of perpetual contract

To determine the price at which an exchange will forcibly close a trader's position, liquidate the perpetual contract position by dividing the maintenance margin by the contract value.

Dec 07, 2024 at 05:23 pm

How to Calculate Liquidation of Perpetual Contract

Perpetual contracts are a type of derivative contract that allows traders to speculate on the future price of an asset without having to take delivery of the underlying asset. Perpetual contracts are typically settled in cash, and they do not have an expiration date. This means that traders can hold perpetual contracts for as long as they want, or until they are liquidated.

Liquidation occurs when the trader's margin balance falls below the required maintenance margin. The maintenance margin is a percentage of the contract value that must be maintained in the trader's account at all times. If the trader's margin balance falls below the maintenance margin, the exchange will automatically sell the trader's position to cover the loss.

The following steps explain how to calculate the liquidation price of a perpetual contract:

1. Determine the contract value.

The contract value is the current market price of the underlying asset multiplied by the contract size. For example, if the current market price of Bitcoin is $10,000 and the contract size is 100 Bitcoin, the contract value would be $1,000,000.

2. Calculate the initial margin.

The initial margin is the amount of margin that is required to open a perpetual contract position. The initial margin is typically a percentage of the contract value. For example, if the initial margin is 10%, the trader would need to deposit $100,000 into their account to open a position with a contract value of $1,000,000.

3. Calculate the maintenance margin.

The maintenance margin is the minimum amount of margin that must be maintained in the trader's account at all times. The maintenance margin is typically a lower percentage of the contract value than the initial margin. For example, if the maintenance margin is 5%, the trader would need to maintain a margin balance of $50,000 in their account to keep their position open.

4. Calculate the liquidation price.

The liquidation price is the price at which the exchange will automatically sell the trader's position to cover the loss. The liquidation price is calculated by dividing the maintenance margin by the contract value. For example, if the maintenance margin is $50,000 and the contract value is $1,000,000, the liquidation price would be $0.05.

5. Monitor the margin balance.

The trader should closely monitor the margin balance in their account to avoid liquidation. If the margin balance falls below the maintenance margin, the trader should add more margin to their account or close their position.

6. Close the position.

The trader can close the position at any time by selling the contract back to the exchange. When the position is closed, the trader will receive the difference between the current market price of the underlying asset and the price at which the position was opened.

7. Withdraw the funds.

Once the position is closed, the trader can withdraw the funds from their account. The funds will be deposited into the trader's bank account or other payment method.