A Perp by Any Other Name: The Rise of US Perpetual Futures
US markets are undergoing a period of rapid change. Retail-centered products like Zero Days to Expiration options (0DTE) are becoming more popular than their traditional counterparts, and major exchanges are moving to expand their trading hours beyond the institutional trading day to 24/5.
These changes are geared towards attracting liquidity from a wider group of investors, such as international traders. They also recognize the power of retail-driven volumes and the emergence of the individual trader as a force in global markets.
Currently, a new instrument is gaining ground in US markets. Designed to simplify futures trading, perpetual futures contracts are easier to trade and more capital efficient. As a result, a number of venues have rushed to get their own versions of this product approved by regulators.
Why are perps such a big deal?
Perpetual futures are a margined derivative that tracks the spot price of underlying assets and allows traders to speculate on asset prices without having to take delivery or manage the rolling of contracts.
Perps are a big deal for traders because they’re much simpler than traditional futures, cheaper to access, and allow for much higher leverage ratios than other instruments.
Perpetual futures contracts can also be issued on any underlying asset, making it an incredibly versatile instrument for gaining exposure to a variety of markets in a highly affordable way.
Why are perps launching in the US now?
As controversial as President Trump’s presidency has been in other domains, his administration has been far less hostile to crypto than his predecessors. This includes the SEC dropping lawsuits against crypto firms, and a less heavy-handed regulatory approach to new financial instruments.
Traders outside of the US have enjoyed access to perpetual futures since BitMEX introduced them on underlying crypto markets in 2016. US traders have been excluded from trading perpetual futures, unless accessing offshore markets or decentralized exchanges via VPNs.
Perps have been an enormously successful instrument in crypto, with volumes dwarfing spot crypto volumes on the exchanges that offer them. Their simplicity and ease of access make them extremely attractive to a variety of participants. US venues are currently taking advantage of regulatory tail winds to introduce this product to US investors.
Are US perps available on stock indices?
Yes, they are. In April, CME group announced the launch of its own version of perpetual futures. They went live on June 30 and are currently available on the S&P 500, Nasdaq 100, Russell 2000, Dow Jones Industrial Average. Like Coinbase, CME also offers this instrument on bitcoin and ether.
CME’s decision to offer a perpetual-like futures product demonstrates that the group recognizes the profit potential of the instrument. The creation of perp contracts on traditional indices suggests a strong demand for flexible, affordable, and simplified access to a broader range of contracts and could be the first step in perp-like futures on a host of different underlying securities.
What are spot-quoted futures?
Spot-quoted futures, or SQFs, as CME group calls them, are the firm’s version of perpetual futures. It’s a new type of longer-dated futures contract available in much smaller sizes than even the micro-E-mini equivalents, or existing micro-Bitcoin and Bitcoin Friday futures.
These contracts are quoted at the spot price instead of the futures price and only expire once per year rather than having to be rolled monthly, or quarterly, like traditional futures contracts.
How do CME spot-quoted futures differ from Coinbase US-style perpetuals?
Coinbase currently only offers its US-style perpetual futures contracts on bitcoin and ether, whereas CME offers spot-quoted futures (SQFs) on bitcoin, ether, S&P 500, Nasdaq 100, Russell 2000, and Dow Jones Industrial Average.
The expirations also differ. CME SPQs expire annually, while Coinbase perpetual futures expire once every five years, allowing contracts to be held for longer without having to roll them.
Another difference between the two is in the contract sizes. While both offer “nano” bitcoin contracts sized at 0.01 BTC, CME’s ether futures are sized at 0.20 ETH per contract, whereas Coinbase’s are sized at 0.10 ETH.
Both venues offer a similar mechanism for ensuring the futures price doesn’t diverge too far from the spot price. This involves the difference between the spot and future prices either being added or subtracted from trader accounts. With CME spot-quoted futures this takes place once per day, on Coinbase this takes place once every twelve hours. Coinbase refers to this as the “funding rate mechanism,” whereas CME refers to it as a “daily financing adjustment.”
What are the risks involved in trading perps?
Perpetual futures are traded on margin, meaning that traders only have to put up a fraction of the overall position they’re taking, this is why these contracts are said to offer high leverage. Margin and leverage are related concepts, with margin being expressed as a percentage, while leverage is expressed as a ratio.
The less margin a trader is required to post in order to cover a position, the more leverage they’re effectively using. So, 10% margin means they are only required to cover 1/10th of the overall cost of the position, which is the same as using 10:1 leverage.
Low margin requirements, or trading with high leverage, amplify both potential profits and losses. This is because if the market moves in favor of the trader, they earn profits on a larger position than if they were required to put up the full amount. This also works in the opposite way. When using high leverage, even relatively small market moves in the opposite direction can cause traders to receive margin calls, and in the worst-case scenario to blow up their accounts.
Can perp trading affect underlying markets?
Yes, when asset prices move abruptly up or down, perpetual futures traders holding positions in the opposite direction can face mass liquidation events. These events can be extremely volatile and highly disruptive to underlying markets.
This is particularly so in crypto where perpetual volumes are far greater than spot volumes, and so a cascade of buying or selling pressure can carry over into underlying spot crypto markets.
There is some evidence to suggest that liquidations in perpetual futures markets can be a leading indicator of spot market movement.
What is the target market of perpetual futures?
Perpetual futures appear to be targeted at retail traders due to the relatively small sizes of the contracts in question. However, they’re also useful for all kinds of speculators who are not interested in taking ownership of the underlying but are primarily concerned with trading its changing value.
Traditional futures emerged as a way for producers and consumers of commodities to be able to hedge against the uncertainty of future prices, effectively locking in the price for future delivery. This removed the uncertainty of market dynamics and allowed deals to be made in the present that were to be honored at a set future date.
This is why futures markets are structured in the manner in which they are, with pre-defined expiration dates and the ability to roll contracts forward. Perpetual futures remove any connection with the underlying markets they track by allowing traders to speculate purely on the changing prices of underlying assets.
Conclusion
Perpetual futures are likely to be great volume generators for the financial firms that decide to offer them in the US. It’s unclear how regulators will deal with the risks that such leveraged products introduce to the retail space, this will be an interesting story to follow as more of these types of contracts are launched.
In Europe, retail traders have had access to contracts for difference (CFDs) for decades. CFDs are a similar margined derivative that allows for speculation on underlying markets without ever having to take possession.
If there is a trend to be observed in the trading of CFDs, as time has passed, regulators have become stricter both in how these products are marketed and in the leverage ratios that are made available to retail participants.
It remains to be seen whether something similar takes place in the US with perpetual futures. It will be left to a future White House administration to reconsider this instrument’s suitability for retail participants. For the moment, though, their relative novelty in the US market is likely to make them very attractive to all kinds of traders.
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