Derivatives vs Futures: Are They the Same?
While exploring cryptocurrency, there’s a high probability you have heard the terms “derivatives” and “futures.” These terms are often used interchangeably, as though they are one side of the same coin. Although derivatives and futures contracts share some trading fundamentals, they serve different trading strategies due to their key differences. In this article, we will delve into the topic of futures contracts to provide a clearer understanding.
What are derivatives
Derivatives are securities whose value is derived from one or more underlying assets. Essentially, a derivative acts as a contract between two or more parties, hinging upon the specified asset(s). The value of these assets is determined by fluctuations in the underlying asset itself, including crypto, stocks, bonds, commodities, interest rates, and market indexes.
Traditionally, Derivatives can be traded either over-the-counter (OTC) or on an exchange. Over time, derivatives have evolved to encompass a wide range of transactions and serve various purposes. In fact, derivatives now extend to include innovative forms tied to crypto assets, such as Bitcoin, Ethereum, Dogecoin, and more.
The versatility of derivatives enables their utilization in risk management, speculation, and leveraging positions. The derivatives market continues to flourish, offering an extensive array of products to cater to diverse needs and risk tolerances. These derivative products can be classified into “lock” and “option.” Lock products encompass futures, forwards, and swaps, the prevalent types of derivatives.
What are Futures
Futures contracts are financial instruments that represent the value of a specific crypto asset at a predetermined time. These contracts are typically agreements between traders, forecasting the buy or sale of a particular asset at a prearranged price on a specified future date. Traditionally, in a futures contract, the position holder is obligated to fulfil the agreement by buying or selling the underlying asset at the contract price upon expiration.
LBank Futures offers traders easy access to trade perpetual futures contracts. Unlike traditional futures contracts, perpetual futures contracts do not have an expiration date, offering greater flexibility in trading.
Derivatives vs Futures
Derivatives and futures are different kinds of financial instruments to trade the markets. The main difference between them is that derivatives derive their value from an underlying asset, while futures are agreements to buy or sell something at a certain price on a specific date in the future.
Derivatives can be traded in different ways, either in special places called exchanges or through private deals. There are different types of derivatives, like forwards, futures, options, and swaps.
Futures, though, are a specific type of derivative. They are only traded on exchanges and involve an agreement to buy or sell something later on at a set price. Because financial markets can be risky and things go up and down, investors use derivatives to reduce those risks. Derivatives, including futures, help make future transactions more certain, so people feel more comfortable dealing with them.
Overall, Futures can be classified as derivatives, highlighting the relationship between the two. Derivatives are a big group of financial things that derive value from underlying assets, while futures are one specific type of derivative. Futures are only traded on exchanges, and they help reduce risk.
Pros of Future Contracts
One of the major benefits of trading futures is the opportunity to open large positions and potentially earn substantial profits with a small initial investment. This is made possible through the use of leverage, which allows traders to control larger amounts of cryptocurrency with less capital. Leverage also enables investors to employ flexible strategies like short-selling to hedge their positions and minimize losses.
Another significant advantage is that trading crypto futures provides indirect exposure to cryptocurrencies without the need to actually own them. Traders/Investors can participate in the crypto market without setting up a crypto wallet, managing seed phrases, or implementing complex risk management measures associated with holding cryptocurrencies securely.
It’s worth noting that LBank, a highly popular crypto exchange, offers futures trading services.
Cons of Future Contracts
One of the main disadvantages involved in trading futures is the potential for forced liquidation. If an investment moves against the trader, there is a risk of being forcibly liquidated. This means that the initial margin, which is the collateral provided to open a leveraged position, is taken by the exchange, resulting in a complete loss of the investment.
The risk of liquidation increases with higher leverage rates. A basic formula indicates that the market only needs to move against the investment by an amount equal to 200 divided by the leverage rate for liquidation to occur. For example, if an investment is leveraged 200 times, a movement of just 2% in the wrong direction could lead to the liquidation of the initial margin.’
It’s important for traders to be aware of the risks involved in trading crypto futures and to exercise caution and risk management strategies to protect their investments.
Wrapping up
The dissimilarity between derivatives and futures primarily lies in their range. Derivatives encompass a wide range of techniques, making them more comprehensive, whereas futures contracts have a narrower focus. Nonetheless, both share a common objective of managing the risk associated with future transactions. Futures, specifically, enable investors to speculate on price movements, leveraging high rates and employing strategies like short-selling to their advantage.
In summary, derivatives exhibit a broader application, incorporating various techniques, while futures contracts are more specialized. Both serve the purpose of mitigating future transaction risks, with futures providing opportunities for investors to capitalize on price fluctuations using leverage and strategic maneuvers such as short-selling.
Disclaimer: The opinions expressed in this blog are solely those of the writer and not of this platform.
