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What is perpetual contract? What are the rules?
Perpetual contracts offer traders flexibility with no expiration dates, continuous settlement, and funding mechanisms to maintain price alignment with underlying assets.
Oct 21, 2024 at 10:48 pm
What is a Perpetual Contract?
A perpetual contract, also known as a perpetual swap or inverse futures contract, is a type of financial derivative that mimics the behavior of a futures contract but without an expiration date. This means that perpetual contracts can be held indefinitely, allowing traders to speculate on the price of an underlying asset for an extended period.
How Does a Perpetual Contract Work?
Unlike traditional futures contracts, perpetual contracts do not have a pre-defined settlement date. Instead, they are continuously traded, with traders able to enter or exit their positions at any time. To keep the price of the perpetual contract in line with the price of the underlying asset, it employs a mechanism called funding.
Funding:
Funding is a periodic payment or charge that is applied to traders' positions in accordance with the market's supply and demand for perpetual contracts. When there is an imbalance between buyers (long positions) and sellers (short positions), the market will pay a premium to incentivise traders to take the opposite position and bring the market back to equilibrium.
Mark Price:
The mark price of a perpetual contract represents the fair market value of the underlying asset at any given moment. It is determined by a weighted average of recent trade prices and is used as the benchmark for calculating funding and profit/loss.
Liquidation:
Traders must maintain a sufficient amount of margin (collateral) on their perpetual contract positions. If the value of a trader's position falls below a certain threshold, they will face liquidation. Liquidation occurs when the broker automatically closes a trader's position to recover the lost margin.
Trading Rules:
- Leverage: Traders can use leverage to trade perpetual contracts, which allows them to control a larger position with a smaller amount of capital. However, it is important to note that leverage also amplifies both profits and losses.
- Margin: Traders must maintain a minimum level of margin to cover potential losses. Insufficient margin can result in liquidation.
- Mark Price and Settlement: Perpetual contracts are settled against the mark price, which acts as the reference price for determining profit/loss. Unlike futures contracts, perpetual contracts allow for continuous settlement without predefined expiry dates.
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