How To Arbitrage From Funding Fees Futures/Spot Hedging

2021/12/22 07:50:35

1. What is Funding Fee Arbitrage?

Funding rate arbitrage is to hedge one investment in the Futures market by trading in Spot one. For instance, if you have a short position in the Futures market, you can buy in the Spot market with the same value to protect your investment from large price volatility and earn funding fees.

2. Why use Funding Fee Arbitrage?

2.1 Funding Rate Mechanism: it is a unique feature of perpetual contracts to reduce the price difference between the perpetual contract and the Spot market. The funding fee is settled every 8 hours. When the funding rate is positive, long position holders will pay the short ones. Likewise, when the funding rate is negative, short position holders will pay the long ones.

2.2 Lower Risk: if you place a buy order in the Spot market and go short in the Futures market with the same value, the value will not change with the fluctuations, offsetting the risk of any adverse price movements. Learn more about Hedge Against Risks via Futures Trading.

2.3 Stable Income: normally, the funding rate is positive. You can keep earning funding fees as long as you hold a short position in the Futures market with a buy order of the same value in the Spot market. The funding fee arbitrage is suitable for traders who want to diversify their investments and seek for a long-term steady growth.

3. How to Arbitrage from Funding Fees?

Step 1: Choose an arbitrage portfolio with the highest annual yield.

The funding fee is settled 3 times each day, and profit = position value * funding rate. Under the same position value, the higher the funding rate, the greater the arbitrage. Learn more about the funding rates of different contracts.

Step 2: Buy the base currency of the chosen contract in the Spot market, and go short the contract with the same value and 1x leverage.

When the buy order in the Spot market and the short position in the Futures market are of the same value, you can start to arbitrage.

Step 3: Wait for funding settlement.

After the settlement of funding fees, you can close positions to reap profit from arbitrage.

For example:

Kutee finds the current funding rate is at a high point, which is a perfect time for funding fee arbitrage. Kutee has 12,000 USDT, and the current price of VET is 0.12 USDT. She then:

1. Keep 6,000 USDT in the Trading Account and transfer 6,000 USDT into the Futures Account.

2. Buy 6,000 USDT worth of VET (position value: 50,000 VET) through Spot trading, then go short 50,000 VET worth of VET Perpetual contract with 1x leverage (initial margin: 6,000 USDT).

See the screenshot below for more details:

3. No matter how the market goes, the gains and losses on the VET spot and contracts offset each other, with a low risk of losing the principal.

4. If the funding rate is 0.2803% and keeps unchanged after three times of settlement, then:

Single profit is 50,000 * 0.12 * 0.2803% = 16.818 USDT

Annualized return is 0.2803% * 3 * 365 = 306.93% 

5. When the funding rate reaches or is lower than your intended one, you can close the position to reap profit from arbitrage.

You can also increase the leverage and repeat the above actions to maximize the utilization of the principal, make sure the value of the Spot order and the contract are the same.

4. Notice

4.1 Liquidation Risks

It is recommended to set lower leverage and Take Profit and Stop Loss to control the risks for positions to better control the risks.

4.2 Keep the Same Value

It is recommended to set the trading unit of the same token/coin. For example, if you buy VET in the Spot market, it is better to set VET as the trading unit in the Futures market.

4.3 Funding Rate

Please pay attention to the changes in the funding rate and close your positions when your expected return is reached.

You can check the funding history of contracts on KuCoin Futures, including perpetual contracts and quarterly contracts.

No matter whether USDT-Margined contracts or COIN-Margined contracts, you can arbitrage from their funding fees. The arbitrage of COIN-Margined contracts is much easier. Simply by holding the coin and going short the corresponding contract with the same value and a 1x leverage, you can realize the arbitrage.