Hedging on futures and between spot and futures markets

• 12th Feb, 2025 09:02 AM

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The cryptocurrency market is known for its high volatility, which creates both opportunities for profit and risks for investors. One of the effective risk management tools is hedging. In this article, we will break down what hedging on futures and between spot and futures means, as well as how to use these strategies to protect your assets.

What is hedging?

Hedging is a strategy aimed at reducing risks associated with asset price changes. It involves opening opposite positions in different markets or instruments to offset potential losses.

"Hedging is your insurance against unpredictable market movements. It does not generate profit but protects against losses."

Hedging on futures

Strategy essence

Futures allow traders to open long (buy) or short (sell) positions using leverage. Hedging on futures involves opening a position opposite to your primary position in the spot market.

Example of hedging on futures

• Situation: You have 1 BTC purchased on the spot market for $30,000. You want to protect yourself from a potential price drop.
• Action: You open a short position on futures for 1 BTC using 1x leverage.
• Result:
  • If the BTC price drops to $25,000, you lose $5,000 on the spot market but earn $5,000 on futures.
  • If the BTC price rises to $35,000, you earn $5,000 on the spot market but lose $5,000 on futures.

Thus, your overall balance remains unchanged regardless of price movements.

When to use hedging on futures?

• When you want to lock in the current value of an asset to avoid losses from a price drop.
• When you expect high market volatility.

Hedging between spot and futures

Strategy essence

Hedging between spot and futures involves simultaneously opening opposite positions in the spot and futures markets. This strategy allows you to profit from the price difference (basis) or protect your assets from unfavorable changes.

Example of hedging between spot and futures

• Situation: You buy 1 BTC on the spot market for $30,000 and simultaneously open a short position on futures for 1 BTC.
• Result:
  • If the BTC price drops to $25,000, you lose $5,000 on the spot market but earn $5,000 on futures.
  • If the BTC price rises to $35,000, you earn $5,000 on the spot market but lose $5,000 on futures.

This strategy is often used to profit from the funding rate paid on futures contracts.

Advantages of hedging between spot and futures

• Allows you to lock in the asset value.
• Provides protection against sharp market movements.
• Enables you to earn on funding rate differences.

Risks of hedging

• Fees: Frequent opening and closing of positions can lead to significant commission expenses.
• Liquidation: On leveraged futures, there is a risk of position liquidation during sharp price movements.
• Price difference: Spot and futures markets may have different prices, affecting hedging efficiency.

Tips for successful hedging

• Use leverage cautiously to avoid liquidation.
• Choose exchanges with low fees for hedging.
• Monitor funding rates on futures to account for their impact on your strategy.
• Don't forget about risk management: don't hedge more than you can afford to lose.

Conclusion

Hedging on futures and between spot and futures are powerful tools for protecting investments in the volatile cryptocurrency market. They allow you to minimize risks and lock in asset values but require a careful approach and understanding of how they work. Using the described strategies and tips, you can effectively manage your risks and maintain stability in any market conditions.