Bitcoin (BTC) has been struggling to break above the $ 60,000 resistance for almost a month. But despite the stagnation, the BTC futures markets have never been so bullish. While regular spot exchanges show a price close to $ 59,600, BTC contracts expiring in June reflect one above $ 65,000.
Futures contracts tend to trade at a premium, primarily in neutral to bull markets, and this is true for all assets, including commodities, stocks, indices, and currencies. However, an annualized (base) premium of 50% for contracts that expire in three months is very rare.
Unlike the perpetual contract, or reverse swap, these fixed-date futures do not have a funding rate. Therefore, its price will differ greatly from what is displayed on regular spot exchanges. Fixed-date futures eliminate potential financing rate spikes from a buyer’s perspective, which can reach up to 43% per month.
On the other hand, the seller benefits from a predictable premium, which is generally used in longer-term arbitrage strategies. By simultaneously buying BTC for cash and selling the futures contracts, you get zero risk exposure with a predetermined profit. Therefore, the seller of futures contracts demands higher profits (premium) each time the markets tilt higher.
Three-month futures are generally traded at a 10% to 20% premium compared to regular spot exchanges to justify blocking funds rather than cashing them out immediately.
The chart above shows that even during the 250% rally between March and June 2019, the futures base remained below 25%. It was only recently, in February 2021, that such a phenomenon reappeared. Bitcoin rose 135% in 60 days before the 3-month futures premium surpassed the annualized level of 25% on February 8, 2021.
While professional traders tend to prefer fixed month futures, retail traders dominate perpetual contracts, avoiding the hassle of expirations. Additionally, retail traders find it costly to pay 10% or more in premiums, even though perpetual contracts (reverse swaps) are more expensive when the funding rate is considered.
While the recent funding rate of 0.20% every 8 hours is extraordinary, it is definitely not unusual in the BTC markets. This fee equals 19.7% per month, but it rarely lasts more than a couple of days.
A high financing rate causes arbitration desks to step in, buying fixed-date contracts and selling perpetual futures. Therefore, excessive leverage from retail longs (buyers) generally drives up the futures basis, not the other way around.
As the crypto derivatives markets remain largely unregulated, discrepancies will continue to prevail. Therefore, while a 50% base premium seems out of the ordinary, we must remember that retail traders have no other means of leveraging their positions. In turn, this causes temporary distortions, although not necessarily worrisome from a business perspective.
While funding rates remain exorbitant, leveraged longs will be forced to close their positions due to their increasing cost. Therefore, the December USD 73,500 contract does not necessarily reflect investor expectations, and such premium should decrease.
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