Understanding Yield through Examples
This section illustrates the concept of yield through hypothetical scenarios.
Let's take an example with $100 of capital to better understand the process.
Contango Arbitrage
Step 1: Buy BTC worth $100 at $60,000. Step 2: Sell BTC July futures worth $100 at $62,000.
Scenario 1: BTC increases in price
Price of BTC increases from $60,000 to $100,000.
Price of BTC July futures will accordingly increase to $103,500.
However, on the day of expiry, BTC July futures will expire at the spot price of BTC, yielding us $3.34 on our capital of $100.
Scenario 2: BTC decreases in price
Price of BTC decreases from $60,000 to $30,000.
Price of BTC July futures will accordingly decrease to $31,000.
In any case, on the day of expiry, BTC July futures will expire at the spot price of BTC, yielding us $3.34 on our capital of $100.
Ultimately, the best thing about the contango arbitrage strategy is that regardless of market direction, profit is assured. Whether the price of BTC increases or decreases, the convergence of futures prices to the spot price at expiry ensures a consistent yield. In this example, with $100 of capital, the strategy yields $3.34 at expiry.
Funding Rate Arbitrage
Step 1: Buy BTC worth $100 at $60,000. Step 2: Sell BTC perpetual futures worth $100 at $60,000.
Scenario A: BTC increases in price
Price of BTC increases from $60,000 to $100,000.
Price of BTC perpetual futures will accordingly increase to $100,000.
We exit the trade in 3 months, having earned $3 on our $100 capital from funding fees received for holding the short position in perpetual futures, irrespective of the market going up.
Scenario B: BTC decreases in price
Price of BTC decreases from $60,000 to $30,000.
Price of BTC perpetual futures will accordingly decrease to $30,000.
We exit the trade in 3 months, having earned $3 on our $100 capital from funding fees received for holding the short position in perpetual futures, irrespective of the market going down.
The funding rate arbitrage strategy provides consistent returns irrespective of the market price of BTC. By buying BTC and simultaneously selling perpetual futures, the strategy earns funding fees over the holding period. Whether the price of BTC increases or decreases, the funding fees collected for holding the short position in perpetual futures yield $3 on the $100 capital over three months.
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