Crypto Futures Spread Trading: A Guide for Institutional Traders using Paradigm and BitSpreader
Crypto futures are contracts that allow traders to buy or sell an underlying cryptocurrency at a predetermined price and date in the future. Crypto futures can be used for hedging, speculation, arbitrage, or portfolio diversification. However, trading crypto futures also involves risks, such as volatility, leverage, liquidity, and counterparty risk. In this article we review how to Spread Trade Crypto Futures, with a look at 2 platforms that facilitate this: Paradigm and BitSpreader.
Crypto Future’s Spread Trading: A Guide for Institutional Traders using Paradigm and BitSpreader
Crypto futures are contracts that allow traders to buy or sell an underlying cryptocurrency at a predetermined price and date in the future. Crypto futures can be used for hedging, speculation, arbitrage, or portfolio diversification. However, trading crypto futures also involves risks, such as volatility, leverage, liquidity, and counterparty risk.
One way to mitigate some of these risks and enhance the profitability of crypto futures trading is to use spread trading strategies. Spread trading is a type of market-neutral strategy that involves simultaneously opening two positions: one long and one short. The aim is to profit from the change in the price difference between the two positions, rather than the direction of the market.
Spread trading can be applied to crypto futures in two ways: cross-asset spreads and calendar spreads. Cross-asset spreads involve trading futures on different cryptocurrencies or their perpetual futures, such as ETH/BTC or BTC/USDT. Calendar spreads involve trading futures on the same asset but with different maturities, such as BTC March 2023 and BTC June 2023.
In this article, we will explain the benefits and challenges of crypto futures spread trading, introduce two platforms that offer this service: Paradigm and BitSpreader, and compare their features and key differences. We will also cover some important concepts and terms related to spread trading, such as contango, backwardation, calendar spreads, and butterfly spreads.
Benefits of Crypto Futures Spread Trading
Crypto futures spread trading can offer several advantages over outright futures trading, such as:
- Lower volatility: Since spread trading involves taking opposite positions on two correlated assets or contracts, it reduces the exposure to market fluctuations and unexpected events. For example, if the price of BTC drops sharply due to a hack or a regulatory crackdown, the loss on the long position can be offset by the gain on the short position.
- Lower margin requirements: Since spread trading reduces the risk of large price movements, it also lowers the margin requirements for opening and maintaining positions. This means that traders can use less capital and leverage more effectively to increase their returns.
- Lower fees: Since spread trading involves fewer transactions than outright trading, it also reduces the fees associated with trading. For example, if a trader wants to buy BTC March 2023 and sell BTC June 2023, they only need to execute one spread trade instead of two separate trades.
- Higher liquidity: Since spread trading involves trading contracts that are more standardized and liquid than individual cryptocurrencies, it also increases the liquidity and depth of the market. This means that traders can find better prices and execute larger orders with less slippage and impact.
Challenges of Crypto Futures Spread Trading
Crypto futures spread trading also has some challenges and limitations that traders should be aware of, such as:
- Complexity: Spread trading requires more analysis and calculation than outright trading, as traders need to monitor not only the price movements of individual assets or contracts, but also the price differences between them. Traders also need to consider factors such as contract specifications, settlement dates, interest rates, funding rates, and implied volatility when choosing and executing spread trades.
- Execution risk: Spread trading involves executing two trades simultaneously or in quick succession, which can pose execution risk if one of the trades fails or gets delayed due to technical issues or market congestion. This can result in an incomplete or unbalanced position that exposes the trader to unwanted risk.
- Counterparty risk: Spread trading involves dealing with multiple counterparties, such as exchanges, brokers, clearing houses, or liquidity providers. This can expose the trader to counterparty risk if one of them defaults or becomes insolvent. This risk can be mitigated by choosing reputable and regulated platforms that offer adequate security and insurance measures.
Paradigm: A Unified Liquidity Network for Crypto Derivatives Traders
Paradigm is a platform that provides a unified liquidity network for crypto derivatives traders across CeFi (centralized finance) and DeFi (decentralized finance). The platform allows traders to access multi-asset, multi-leg, multi-protocol liquidity on-demand without compromising on price, size, execution costs, and immediacy.
Paradigm connects traders directly with institutional counterparties in its network, such as market makers, OTC desks, hedge funds, family offices, and professional traders. Traders can request quotes for any instrument or strategy via RFQ or access streaming order books for delta-1 spreads. Traders can also bid for DeFi option vault options flow and settle directly on-chain.
Paradigm supports a wide range of products, such as options, perpetuals, futures, and spreads on top cryptocurrencies. Traders can also trade any combination of these products as multi-leg strategies, such as straddles, strangles, butterflies, condors, etc.
Paradigm is integrated with several CeFi exchanges and DeFi protocols that allow traders to settle their trades on the venue of their choice.
One of the unique features of Paradigm is its block trading feature for futures and options. Block trading allows traders to negotiate and execute large-size trades privately and securely without affecting the market price or liquidity. Block trades are reported to the relevant exchange or protocol after execution and are subject to minimum size and price requirements.
Paradigm uses implied orders whereas an implied order is an order that is not explicitly placed in the market, but is inferred from other orders in related markets. For example, an implied order can be a spread order that is created from individual outright orders in the market (implied IN), or an outright order that is created from a spread order and an outright order in one of the legs (implied OUT). Implied orders can increase the liquidity and efficiency of the market by linking the spread and outright markets.
BitSpreader: A Crypto Spread Trading Platform
BitSpreader is a platform that specializes in crypto futures spread trading. The platform allows traders to trade over 120 synthetic cross-exchange calendar spreads on various cryptocurrencies. BitSpreader constructs and streams implied cross-market order books in real time and allows traders to manage their spread positions and exposure.
BitSpreader supports both intra-exchange and cross-exchange spreads. Intra-exchange spreads involve trading futures contracts on the same exchange but with different maturities. Cross-exchange spreads involve trading futures contracts on different exchanges but with the same or similar maturities. For example, a trader can trade BTC March 2023 on Binance and BTC March 2023 on Deribit as a cross-exchange spread.
BitSpreader also offers geographical co-location of servers, to provide traders with the fastest possible execution times whereby traders can choose the location that guarantees the best execution times for their trades. Co-locating the trading server in the optimal location for the trader (US, Europe or Japan) will minimise risk of slippage.
BitSpreader also offers a low latency, high-frequency spread trading method called auto-spreading. Auto-spreading involves placing and updating limit orders on one side of the spread and hedging with market orders on the other side. This method is suitable for catching short-lasting spreads and reducing transaction costs.
BitSpreader is a cloud-based solution that does not require any software installation. Traders can access the platform with their browser and provide their exchange API keys to BitSpreader. BitSpreader uses the API keys to execute orders on the exchanges on behalf of the traders. BitSpreader does not take custody of the traders’ funds or assets.
Auto-spreading is a feature of BitSpreader, a platform for spread trading on cryptocurrency futures. Auto-spreading allows the user to provide a limit spread price and BitSpreader will actively place and update a limit order on one market based on the current price on another market. When the limit order is filled, BitSpreader will instantly hedge it by executing a market order on another market. Auto-spreading can help the user to capture the spread profit and reduce the market risk.
Comparison of Paradigm and BitSpreader
Contango and Backwardation in Crypto Futures
Contango and backwardation are terms that describe the relationship between the spot price and the futures price of a commodity. They indicate whether the market expects the price of the commodity to rise or fall over time.
Contango is when the futures price is higher than the spot price. This means that the market expects the price of the commodity to increase in the future. A contango market is usually represented by an upward-sloping forward curve.
Backwardation is when the futures price is lower than the spot price. This means that the market expects the price of the commodity to decrease in the future. A backwardation market is usually represented by a downward-sloping forward curve.
Contango and backwardation can affect the profitability of crypto futures spread trading. For example, if a trader buys a near-term contract and sells a far-term contract in a contango market, they will incur a loss if the price difference between the two contracts narrows over time. Conversely, if a trader sells a near-term contract and buys a far-term contract in a backwardation market, they will incur a loss if the price difference between the two contracts widens over time.
Therefore, traders need to monitor the shape of the forward curve and adjust their positions accordingly. Traders can also use indicators such as basis (the difference between spot and futures prices) and implied volatility (the expected volatility of future prices) to gauge market sentiment and expectations.
Calendar Spreads and Butterfly Spreads in Crypto Futures
Calendar spreads and butterfly spreads are two common types of spread trading strategies that can be applied to crypto futures. They involve trading futures contracts on the same asset but with different maturities.
A calendar spread is a strategy that involves buying a near-term contract and selling a far-term contract, or vice versa. For example, a trader can buy BTC March 2023 and sell BTC June 2023 as a calendar spread. The trader expects the price difference between the two contracts to change in their favor over time.
A calendar spread can be profitable in two scenarios:
- If the market is in contango and the trader sells the near-term contract and buys the far-term contract, they will profit if the contango narrows over time (i.e., the futures price converges toward the spot price).
- If the market is in backwardation and the trader buys the near-term contract and sells the far-term contract, they will profit if the backwardation widens over time (i.e., the futures price diverges from the spot price).
A butterfly spread is a strategy that involves buying or selling two calendar spreads with a common middle leg. For example, a trader can buy BTC March 2023 and sell BTC June 2023, and also buy BTC June 2023 and sell BTC September 2023 as a butterfly spread. The trader expects the price difference between the two calendar spreads to change in their favor over time.
A butterfly spread can be profitable in two scenarios:
- If the market is in contango and the trader sells the butterfly spread (i.e., sells the near-term contract, buys two of the middle-term contract, and sells one of the far-term contract), they will profit if the contango flattens over time (i.e., the futures price becomes more linear).
- If the market is in backwardation and the trader buys the butterfly spread (i.e., buys the near-term contract, sells two of the middle-term contract, and buys one of the far-term contract), they will profit if the backwardation steepens over time (i.e., the futures price becomes more curved).
A possible example of spread trading is the calendar spread on Bitcoin futures. This involves two outright contracts with different delivery dates, such as:
- BTC-USD-30JUN23 — Bitcoin futures contract that expires on 30th June 2023
- BTC-USD-30SEP23 — Bitcoin futures contract that expires on 30th September 2023 To buy the calendar spread: BTC-USD-30JUN23 — BTC-USD-30SEP23, one would take a long position on BTC-USD-30JUN23 and a short position on BTC-USD-30SEP23.
- To sell the calendar spread: BTC-USD-30JUN23 — BTC-USD-30SEP23, one would take a short position on BTC-USD-30JUN23 and a long position on BTC-USD-30SEP23.
- Reducing the risk By taking a long position on BTC-USD-30JUN23 and a short position on BTC-USD-30SEP23, one would be less affected by the price fluctuations of Bitcoin. One could say that one is immune to Bitcoin price movements, but this is not completely accurate. If the Bitcoin price rises, both contracts will increase in value. The gain from the long BTC-USD-30JUN23 will offset the loss from the short BTC-USD-30SEP23 position. The same applies in the opposite direction — if the Bitcoin price falls, the profit from the short position will balance out the loss from the long position.
- For USD-margined futures, one does not need to hold any bitcoin at all — one has no exposure and only keeps USDs in the margin account.
Leverage & Margin Futures contracts are often leveraged, and the leverage on cryptocurrency exchanges can range from 20 to 100. With a leverage of 100 and a Bitcoin price of 20k USD, one only needs 200 USD to buy or short-sell one bitcoin. Although a single spread trading cycle (buying and selling the spread) may yield a smaller profit than what outright traders may expect, leverage can amplify it significantly.
If both legs of the spread are on the same exchange, some exchanges may recognize the calendar spread and lower the margin requirements even more — which enhances your capital efficiency even further.
Crypto futures spread trading is a sophisticated and potentially profitable strategy that allows traders to take advantage of price differences between different contracts or exchanges. However, it also requires careful analysis, execution, and risk management. Traders who want to engage in crypto futures spread trading should choose a platform that offers them access to liquidity, flexibility, security, and tools. Paradigm and BitSpreader are two platforms that cater to different needs and preferences of crypto futures spread traders. Traders should also understand the concepts and terms related to spread trading, such as contango, backwardation, calendar spreads, and butterfly spreads.
Author: Navneet Giri - Navneet is a professional quantitative trader with extensive experience in derivatives trading across major global exchanges and financial markets, including cryptocurrencies.
He employs market-making strategies and participates in liquidity enhancement programs to achieve optimal trading results.