Trading bitcoin inverse futures contracts
On exchanges like Bitmex, Deribit & Bybit, you can trade futures contracts. To trade them against USD without the requirement to actually “interact” with USD. Exchanges avoid regulation, and traders can trade without the need to hold/deposit USD.
When you are trading BTC on Deribit, Bitmex, or Bybit, you are using the inverse futures contracts. Perpetual and the two other quarterly futures contracts are inverses.
To be precise. On Bitmex, all BTC futures contracts are inverse futures contracts (except the UPs/DOWNs). The only linear futures contracts are Cardano, BCH, EOS, Tron, Litecoin, and XRP.
If you need more info about futures trading before you continue reading, check out my other articles.
If you’re interested or missed it, I wrote down my trades in a medium article
Now let’s say you would open a long position with 1x leverage (unleveraged). You would expect only to get margin called if the price drops to 0 (just like with linear markets), but this is not the case with inverse futures contracts. You will be margin called when the price drops lower than 50%
Why does that happen? It’s because you are not trading BTC/USD but USD/BTC. Which is vital to understand. When you long USD/BTC, you are short inverse.
So on inverse USD/BTC, it’s quoted at BTC/USD, and the chart also is shown as BTC/USD, which is confusing for many traders. So to go long on Bitcoin, you would have to be short on USD/BTC. If you short unleveraged, you won’t get margin called. However, your losses do increase, just no margin call.
Let’s say you long at $16k with 1x leverage with 16000 contracts and 1 contract being worth $1, which is equal to 1 BTC, and you can calculate your profit and loss like this. For the sake of simplicity, I leave out fees.
ep = entry price ex = exit price N = number of contractsPNL = (1/ep - 1/ex) * N
PNL = (1/16000 - 1/8000) * 16000 = -1
Your loss is -1 or -1 BTC, meaning your collateral for this long is gone. Liquidation can be earlier; make sure to use Bitmex calculator to calculate it.
Long on inverse
When you long with 1x leverage on the inverse, you are margin called if the price drops more than 50%. So basically, if you are long on an inverse futures contract, you are not using 1x leverage but actually on 2x leverage. If we use 5x leverage on inverse futures contracts, the long position would be 6x leverage in the linear futures contract in terms of USD. The leverage is leverage+1.
Another thing, due to the fundamentals of the contracts, with 1x leverage on an inverse futures contract, your ROI can never reach 100%
This example is straight from Bitmex futures guide
A trader goes long 100 XBT of XBTUSD at 600 USD. He is long 100 XBT * 600 USD = 60 000 contracts. A few days later, the price of the contract increases to 700 USD
The trader’s profit will be:
60 000 * 1 * (1/600 - 1/700) = 14.286 XBTIf the price had dropped to 500 USD
the trader’s loss would have been:
60 000 * 1 * (1/600 - 1/500) = -20 XBTThe loss is greater because of the inverse and non-linear nature of the contract. Conversely, if the trader was short then the trader’s profit would be greater if the price moved down than the loss if it moved up.
Short on inverse 1x leverage to lock-in USD (hedge)
When opening a 1x leverage short on an inverse futures contract, you will “lock in” the USD value. It’s the reason why many professional traders short BTC on an inverse futures contract. It’s a great hedge. When you’re short with 1x leverage on an inverse futures contract, it’s almost impossible to get margin called. You could enter a short at $10k, and BTC could move to 1 million dollars, and you would still not be margin called. This is great for hedging.
Your short position with 1x leverage is always worth the number of dollars because when you short on BTC/USD on an inverse futures contract, you are actually long on USD/BTC. You buy an amount of USD priced in BTC.
Now let’s do some calculations. Imagine the price of BTC is $8000, and we open a short with 2 BTC, which is 16000 contracts (worth $16k). The price goes to $10000, and we can calculate our PNL.
ep = entry price ex = exit price N = number of contractsPNL = (1/ex - 1/ep) * N
PNL = (1/10000 - 1/8000) * 16000 = -0.4 BTC
We lost 0.4 BTC and left with 1.6 BTC, but BTC is now at $10k
1.6 * 10 000 = $16 000But what if we are short with 1x leverage and the price goes from $8000 to $5000 with 16000 contracts (worth $16k or 2 BTC)
ep = entry price ex = exit price N = number of contractsPNL = (1/ex - 1/ep) * N
PNL = (1/5000 - 1/8000) * 16000 = 1.2 BTC
We now gained 1.2 BTC extra with our initial 2 BTC.
2 BTC + 1.2 BTC = 3.2 BTC
3.2 * 5000 = $16000When you leverage short BTC with 1x leverage, you are going into “synthetic” USD. Please remember if you’re doing this on the perpetual swap (XBTUSD), you will either pay or receive the funding rate.
An Inverse futures contract has a non-linear nature. We’re shorting USD when we go long on BTC/USD inverse futures contract. The more BTC goes up in the dollar, the less our position is worth in BTC. Due to the contract being inverse.
Check the values and the mark prices from the futures contracts. You see that the price of BTC went up, the contract size (each contract being worth $1) stayed the same. Yet, the value of my long position in XBT went down.
The payouts work like this too. Every move up gives fewer and fewer gains in BTC (every BTC will be worth more USD); however, the profits in USD are amplified compared to, for example, holding in your bitcoin wallet.
All this has been once pointed out by 1 of my favorite traders on Twitter: https://twitter.com/ThinkingUSD
https://www.bitmex.com/register/vhT2qm
https://www.bybit.com/en?affiliate_id=6776&group_id=1653&group_type=1
