Big talk about contract arbitrage: It is easier to make money in a market with a lot of retail investors?
Author | Qin Xiaofeng
Editor | Lu Xiaoming
Produced | Odaily
Author | Qin Xiaofeng
Editor | Lu Xiaoming
Produced | Odaily
For exchanges, contract trading is another blue ocean of traffic, and many exchanges including Huobi and Binance have entered the market one after another.
However, cryptocurrency investors have always had mixed reviews of contract trading.
For retail investors, how to play contract trading? How to arbitrage through contracts?
Guest introduction:
On September 11, Pento, a senior contract trader of Coin, visited the Odaily Chaohua community to explain "contract arbitrage" in detail.
Pento said that due to the large number of retail investors in the currency circle, the strong nature of the game, and the natural defects of centralized trading, contract trading itself has many irrational opportunities to make money, the risk of arbitrage trading is small, and the income is stable (still far more than Expected returns in traditional financial markets), suitable for people with low risk appetite.
Pento, a partner (private equity) of a well-known large-scale asset management institution in China, is mainly responsible for the investment business of A shares and US stock funds.
From 2002 to 2007, he studied DT in an intraday trading company in the United States and managed multiple trading teams; from 2009 to 2013, he was responsible for the theme research and investment of growth stocks in a mutual fund in the United States; in 2017, he learned about the currency circle and started at the end of 2018 Recruiting a team to conduct contract transactions in the currency circle, currently managing the trading teams of 3 currency circles (now a lot of funds have been withdrawn and returned to investors).
The following is the sharing and arrangement of Pento:
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1. Why do arbitrage opportunities exist?
New venues are easy to make money. This sentence is particularly appropriate to describe the currency circle.
In the 17-year bull market, the price difference of bitcoins on different exchanges in various countries has reached an exaggerated degree. The spot price of bitcoins on Japanese and Korean exchanges is generally at a premium, and many brick-moving parties have made good profits. In addition, the OTC transactions between fiat currency and bitcoin are not standardized, and the quotations are chaotic. Some spot acceptors fish in troubled waters and make a lot of money.
However, at that time, in the bull market, 100-fold coins abounded, and the value of market participants was increasing rapidly. Many people felt that spot arbitrage was tiring and ignored this part of the profit.
In the 2019 bull market, the spot arbitrage space was greatly reduced. Contract trading contributes to the main trading volume of the market, and the popularity of leverage has contributed to the sharp rise and fall of prices. Opportunities for contract arbitrage are still common, but they have certain technical content.
In the stock market, all traders submit their orders to the exchange through a securities company for unified matching. The stock of a company is generally only listed on one exchange. A small number of companies may also be listed on different exchanges at the same time (for example, there are many companies with AH shares listed at the same time). Although the same stock represents the same shareholder rights, it cannot be circulated on different exchanges.
For example, on September 10, Haitong Securities' Hong Kong stock price was 8.75 Hong Kong dollars per share, but the A-share price was as high as 15.12 yuan. For stocks of the same listed company, the price of A shares is twice as high as that of Hong Kong stocks. Traders arbitrage and want to transfer Hong Kong stocks to A shares and then sell them (this is impossible).
Since it is not possible to move bricks, it is always possible to short A-shares and long the same stock in Hong Kong stocks for price convergence and arbitrage. But friends who are familiar with the stock market should generally understand that due to liquidity and different participant groups, the premium of A shares/Hong Kong shares is common, although it may eventually converge, and it often lasts for a long time, and in practice But the requirements are relatively high: buy Haitong Securities after opening an account in the Hong Kong stock market, and short Haitong Securities on the A-share side. You also have to bear transaction costs and exchange rate risks. The opportunity for arbitrage seems obvious, but it is difficult to operate.
The existence of contract arbitrage opportunities in the currency circle is mainly related to the contract mechanism and design.
The funding rate itself is also the best indicator for judging the long and short strength and sentiment of the market.
1. Funding Rate of Perpetual Contract
The funding rate of the perpetual contract is the greatest innovative mechanism invented by the currency circle beyond the traditional futures. The funding rate realizes the reverse swap mechanism through long-short exchange interest, so that the latest transaction price of the contract can be close to the spot price. Friends who have done traditional commodity futures or stock index futures should understand that they should stay away from the dangers of spot price speculation and malicious squeeze.
2. The price difference between the perpetual contract and the delivery contract
The original intention of traditional futures trading is to serve the hedging and hedging needs of spot traders. Exchanges in the currency circle in mainland China learned from traditional futures and launched a large number of delivery contracts (mainly quarterly contracts). Overseas exchanges are known for their perpetual contracts, such as BitMex’s inverse perpetual contracts, BitCoke’s hybrid perpetual contracts, etc.
The pace of the currency circle is fast, and the market sentiment is erratic. In the atmosphere of the bull market, the price difference between the perpetual contract and the delivery contract often moves from one extreme to the other. Large price fluctuations often cause great harm to retail investors, but are good for arbitrageurs.
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2. Three main arbitrage operations in contracts
This year, I have operated the three arbitrage strategies of capital rate arbitrage, intertemporal arbitrage, and cross-species arbitrage. Let me briefly talk about the logic and implementation process for your reference.
1. Arbitrage BitMex’s ETH contract funding rate on BitCoke exchange
My favorite arbitrage strategy is to arbitrage the Funding Rate of BitMex's ETH perpetual contract.
In order to maintain the balance between long and short in the market, the funding rate of the perpetual contract is exchanged every 8 hours. Due to special reasons (not to be disclosed), the funding rate of BitMex’s Ethereum perpetual contract is paid forward most of the time, that is, long positions Pay shorts. As can be seen from the figure below, from March 11 to June 18 this year during the Ethereum bull market, BitMex’s ETH contract funding rate was positive for 99 trading days, and the bulls paid the shorts every day.
The figure below shows the daily price and rate of ETH during this period. It can be seen that although BitMex’s ETH contracts are rising, the longs have to pay the shorts a lot of funding rate (Funding Rate) every day. The highest one-day rate during this period is 0.83%, which is very impressive.
Because the rate on BitCoke is low, the rate on BitMex for long payouts is rich (above). An ETH short order of US$1 million can earn up to US$8,000 in interest on BitMex a day.
2. Arbitrage the price difference between the quarterly contract and the perpetual contract in OK
This arbitrage strategy is believed to be followed by many veteran traders. Before mid-June this year, the price difference between Ok’s quarterly contract and BitMex’s perpetual contract was not very significant. After mid-June, the bull market entered an acceleration period, and retail investors activated their accounts to enter the market. OK’s quarterly contract soon changed from The discount turned into a premium, and the premium continued to increase as the market rose, reaching an astonishing $800 at the highest. Figure: The price difference between OK’s quarterly contract and BitMex’s perpetual price continued to widen after mid-June.
As a rule of thumb, a premium of $300+ for quarterly contracts over perpetual contracts indicates that the market is dominated by bulls.
A premium of more than $500 generally indicates that the market has entered a period of frenzy, and most market participants are doing more to push up the market. The frenzied atmosphere can also be verified by the funding rate of the perpetual contract. A negative premium often indicates pessimism about the market outlook.
For the operation of arbitrage funding rate, I generally operate with a positive premium of $500 as the threshold. Short quarterly contracts on OK, and simultaneously open long orders on BitMex or BitCoke.
In contract trading, thanks to the fact that traders can freely transfer funds between different exchanges, and the underlying market price of the contract follows the spot price, I think it is impossible for the long-term large premium or discount of the delivery contract to last for a long time.
3. Arbitrage the strength of varieties with high correlation
Profiting from the price difference relationship of highly correlated commodities is a common arbitrage method in futures trading. Continental futures popular threads combine with classic arbitrage varieties such as iron ore, coking coal coke, soybean meal and rapeseed meal. The reason why the trends of these varieties are highly correlated is either due to the relationship between the upstream and downstream of the industrial chain, or the mutual substitution relationship between products.
During this year's bull market until now, it may be obvious to many that Bitcoin's correlation with other digital currencies is decreasing. The same rise and fall of the last round of bull market has become a historical memory. Market participants are more rational, holding a magnifying glass to examine the fundamentals and hype logic of different cryptocurrencies. Before the arbitrage of related varieties, it is necessary to understand the history and characteristics of this relationship, supplemented by sophisticated statistical data to verify the trend of correlation, in order to do arbitrage of different varieties.
Figure: Correlation matrix of each digital currency (past year)
From the correlation matrix above, we can see that the correlation between ETH and BTC is relatively high, and the contract volume of both can be relatively large. I prefer to take Ethereum as the main product for shorting, especially after the bull market peaked, I roughly analyzed that ETH may be worthless. From July to August, I mainly adopted the strategy of long BTC and short ETH. I did not expect arbitrage to play out. Surprised.
Doing long Bitcoin and shorting Ethereum is the strategic combination that I have operated a relatively large amount of funds this year
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3. Yield Analysis and Disadvantages of Contract Arbitrage
Arbitrage trading is a relatively stable income. As long as the margin is sufficient, there is actually no risk in arbitrage with a little leverage. But in my heart, I don't recommend ordinary retail investors with small funds (less than 100,000 US dollars) to conduct arbitrage operations.
The arbitrage opportunities for perpetual contracts and delivery contracts on OK itself are limited in a year (bull markets are often short-lived). Funding rate arbitrage requires sufficient margin. The most profitable cross-variety arbitrage requires strong mathematical analysis ability. After judging the correct direction, with 5 times leverage, it is thankful to have a 100% rate of return in a year.
For ordinary people, contract arbitrage has obvious disadvantages:
1) The potential gains from arbitrage are limited, which is a characteristic of arbitrage strategies. Limiting risks also limits profits.
2) Arbitrage requires higher capital and preparation work:
own accounts on multiple exchanges;
There are many coins and sufficient margin, and the arbitrage platform supports the form of combined margin, such as OKEx, BitMex (single-species combined margin), BitCoke (multi-species combined margin);
Conduct mathematical statistics and analysis on a regular basis;
In short, stable happiness is not easy to come by. Contract arbitrage may sometimes be thankless, and it is not as fast as stud getting rich.
The following is the community Q&A session:
The above is the content of the text I shared today for your reference, I hope it will be helpful.
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The following is the community Q&A session:
Q1: You just mentioned the method of contract arbitrage. If everyone learns it, will there be no such bonus space?
Pento：Pento: Of course, every market is the same. Too many people use the same strategy. Too crowded trading will quickly reduce the profit margin and eventually lead to losses. The contract arbitrage method I shared today is effective in the specific market environment in the first half of this year, and it has basically made no profit so far.
There will still be new arbitrage opportunities and methods. Pay more attention to market trends and watch less. Patience is a virtue.
Q2: A fact that cannot be ignored is that the vast majority of retail investors end up losing money when playing contracts. Are retail investors really suitable for playing contracts?
The instigator of the large-scale losses of retail investors is actually himself. In the long run, Bitcoin has been rising continuously. It should have made everyone rich, but it did not benefit most people.
Because too many people participate in highly leveraged contract speculation with the expectation of getting rich quickly. Because they do not have professional trading thinking and methods, and are stimulated by various myths in the market, it is easy for ordinary retail investors to engage in high-risk risk-taking behaviors, and naturally suffer serious losses.
Investors are often overconfident. Even if I say that retail investors are not suitable for playing contracts, it is estimated that retail investors will still flock to them driven by wealth.
Pento：What I can suggest is that if you want to survive in contract trading, you should basically lower your leverage, lower your profit expectations, lay a solid foundation in basic technical analysis, and find a suitable capital position management style and trading method.
Don't just go up 10 times or 20 times at every turn, and treat the contract as a financing transaction of 2-3 times, maybe you can have a better mentality and enjoy the long-term rising dividend.
Q3: At present, the three major exchanges have entered the contract market. Which one do you think has the best experience, the highest depth, and the greatest development potential?
I have opened accounts for Huobi and Binance, but I have no deposit experience. Let me briefly comment on the exchanges where I have an account.
BitMex: It is suitable for trading with API, and the liquidity used to be very good. This year, some market makers may have been lost due to investigations and compliance requirements. The exchanges run by Guilo generally belong to the type of exchanges after the rules are formulated, and the product experience is average. When there is a market, it may be overloaded and unable to log in.
BitCoke: The mixed contract of this exchange is an advantage, and the functions of stop profit and stop loss, conditional order are better, and the transaction cost is low. Now it is my preferred platform for arbitrage.
Pento：OKEx: OK’s quarterly contracts are more popular with retail investors, and it provides otc, currency trading and other services. Due to the reasons I mentioned above, the quarterly contract may be manipulated and needled, and it has been criticized in the community.
As for which one has the greatest potential, it is beyond the scope of ability, and I don’t know much about the current competitive landscape and development trends of exchanges.
Q4: Do overseas institutions have a high acceptance of Bitcoin as a safe-haven asset? Does Bitcoin have the potential to be a true safe-haven asset?
Pento：There are two groups of people who have the highest acceptance of Bitcoin overseas: one is tech geeks, programmers and cyber hackers who are anti-social and traditional like Jobs, which is similar to China; the other is those who are extremely disgusted with the 10-year low interest rate policy of the Federal Reserve rebels in the financial circle.
Their common claim is that BTC is used as a means of checking and balancing the unlimited issuance of money by central banks. Due to strict internal risk control requirements, traditional financial institutions do not dare to touch alternative investments such as Bitcoin.
Q5: By browsing your Weibo, I found that you have made a lot of profits in cooperative transactions, earning dozens of BTC at every turn. I would like to ask if there is any trick to this? It should be difficult to obtain such a high return by arbitrage, right?
Pento：Arbitrage is of course impossible to make so much money this year. Just an opportunity to dig. This year's bull market made money, at the most it was about 4 million a night.
Mainly by doing long bitcoin contracts. Always do long, do not guess the top, so it is mainly due to the market. Because the principal is relatively large, it was also mentioned in the sharing of the coin before. In fact, the actual currency-based rate of return is only about 250-300%.
Pento：Q6: You used to say that you can continue to make money in the Bitcoin market without advanced technical analysis. Where is the main source of excess returns?
It is easier to make money in a market with a lot of retail investors. There are still external capital inflows to support the price of Bitcoin, then the market will make profits as a whole, and those who pay are retail investors who don't know where they are and future takers.
Pento：Q7: How to judge the stage top of a market?
