Understanding Mark Price in Perpetual Futures Contracts on LBank
In futures trading, the position value is commonly marked to the most recent trading price. Nonetheless, this technique may result in unnecessary liquidation if the market is manipulated or lacks liquidity, resulting in significant fluctuations between the Mark Price and the corresponding Index Price.
To solve these challenges, LBank utilizes a fair price marking mechanism. This approach guarantees an equitable price by augmenting a diminishing funding basis rate to the underlying index price.
The mark price serves as a reference point for assessing the value of the underlying cryptocurrency in a trade. It plays a crucial role in determining the unrealized profit and loss of a trade, giving traders a more precise understanding of its potential profitability. This article will explore the concept of mark price in LBank’s perpetual futures contract
The Role of Mark Price in Perpetual Futures Contracts
Perpetual futures contracts are designed to allow traders to speculate on the price movement of an underlying asset without the need for an actual delivery of the asset. These contracts are often leveraged, enabling traders to amplify their potential gains or losses. To ensure the accuracy of unrealized PnL calculations and prevent unnecessary liquidations, it is essential to have a reliable reference price, which is where the Mark Price comes into play.
The Index Price: Foundation of the Mark Price
The Index Price serves as the foundation for calculating the Mark Price in perpetual futures contracts. It represents the “true” value of the contract and is derived from an average of prices on major spot market exchanges. The inclusion of multiple exchanges in this calculation helps reduce the impact of anomalies or price manipulation on a single exchange.
The exchanges used to calculate the Index Price typically include well-known platforms such as Bitfinex, Binance, Huobi, OKEx, Bittrex, and HitBTC. These exchanges are chosen for their liquidity and reliability, making the Index Price a robust reference point for the Mark Price.
Protection Mechanisms for Reliable Index Price Calculation
To ensure the reliability of the Index Price calculation, various protection mechanisms are in place to address potential issues:
- Single Price Source Deviation: If the latest price on a particular exchange deviates by more than 5% from the median price of all price sources, the exchange’s weight in the calculation is set to zero, reducing its influence on the Index Price.
- Multi Price Source Deviation: If more than one exchange exhibits a greater than 5% deviation, the median price of all price sources is used as the index value, rather than the weighted average.
- Exchange Connectivity Problem: In the event of connectivity problems with an exchange, but with recent trade data available (within the last 10 seconds), the last resulted price data is used for the index calculation. If an exchange experiences no updates for 10 seconds, its weight is set to zero during the weighted average calculation.
Calculating the Mark Price
With the Index Price established as the reference “Spot Price,” the Mark Price is calculated based on a formula that takes into account the Funding Rate, which is a key component in perpetual futures contracts. The Funding Rate, updated every 8 hours, is the most recent prior Funding Rate at the time of calculation. The formula for Mark Price is as follows:
Mark Price = Index Price × (1 + Basis)
Where:
- Basis = Funding Rate × (Time Until Funding / 8)
To illustrate this calculation, consider the following example:
- Funding Rate = 0.04%
- Time Until Funding = 5
- Index Price = 12,000
Basis = Funding Rate × (Time Until Funding / 8) = 0.04% × 5/8 = 0.025%
Mark Price = Index Price × (1 + Basis) = 12,000 × (1 + 0.025%) = 12,003
Mark Price serves as a more stable and reliable estimate of the contract’s true value compared to the potentially volatile prices seen in short-term trading of perpetual futures. It plays a crucial role in calculating unrealized PnL and safeguarding traders from unwarranted liquidations.
Unrealized PnL Calculation
Unrealized PnL is a significant metric for traders in perpetual futures contracts, as it indicates the potential profit or loss they would incur if they were to close their positions at the current Mark Price. The calculation of Unrealized PnL varies based on the trader’s position:
- Net Negative Position: Unrealized PnL = (Entry Price — Mark Price) × Size of Position
- Net Positive Position: Unrealized PnL = (Mark Price — Initial Buy Price) × Position Size
Moreover, the total collateral for margin and liquidation purposes can be calculated as follows:
Collateral = Initial Collateral + Realized PnL + Unrealized PnL
It’s important to note that traders can withdraw collateral from their accounts as long as the collateral amount remains greater than the initial margin plus any borrowed funds.
Pros and Cons of Perpetual Futures Contracts
Perpetual futures contracts offer several advantages, but they also come with their share of disadvantages. Understanding these pros and cons is crucial for traders:
Pros
- High Leverage: Perpetual futures contracts provide traders with high leverage options, allowing them to amplify their potential gains.
- No Need for Continuous Rollovers: Unlike traditional futures contracts, perpetual futures contracts do not require periodic rollovers, simplifying trading strategies.
- Hedging and Risk Management: Traders can use perpetual futures contracts to hedge their risks in both margin and spot trading.
Cons
- Lack of Regulation: Perpetual futures contracts are largely unregulated, which means traders have limited protection in case of disputes or market manipulation.
- Counterparty Risk: The absence of an expiration date increases the risk of counterparty defaults, as traders rely on the exchange to honor their obligations.
- Not Authorized by Regulatory Agencies: Perpetual futures contracts are not authorized by regulatory bodies such as the United States Commodities Futures Trading Commission (CFTC), leaving traders without regulatory oversight and protection.
- Complexity: These contracts require traders to understand various components, including Mark Price, Funding Rate, and liquidation mechanisms, making them relatively complex.
Wrapping Up
Mark Price is a critical component of perpetual futures contracts on platforms like LBank, serving as a reference point for accurate unrealized PnL calculations and preventing unnecessary liquidations. Traders must grasp the importance of the Index Price, the calculation of Mark Price, and the mechanisms in place to protect the integrity of these values.
While perpetual futures contracts offer high leverage and flexibility, traders should also be aware of the associated risks, such as counterparty risk and the absence of regulatory protection. A solid understanding of the mechanics and nuances of perpetual futures trading is essential for success in this dynamic and volatile market.
Disclaimer: Derivatives are often volatile, and this can be a risky investment. The information provided in this article is solely for educational purposes and shouldn’t be regarded as financial advice.
