Do You Understand NDCs and How to Trade Them?
NDCs or non-deliverable contracts refer to derivative contracts in trading. The terms NDCs and NDFs (non-deliverable futures) are sometimes used interchangeably when referring to derivative trading. In the cyptocurrency space, the two most widely traded types of derivative contracts are futures and options.
The value of a derivative contract or instrument is linked to an underlying asset. For example, in the stock market, there are futures and options of specific stocks like Apple or IBM. There are derivative contracts of commodities, like corn futures or crude oil futures. Similarly, in the cryptocurrency space, there are futures options, and even perpetual contracts linked to various cryptocurrencies.
A derivative instrument itself does not have any inherent value. Its value is derived from the price of the underlying asset that it follows. A Bitcoin future or option will derive its value from the price of Bitcoin while an Ethereum derivative contract will change with the price of Ethereum.
Futures and options have a specific time value after which they expire. However, cryptocurrency platforms also offer perpetual contracts which are not bound by time. Having a fixed time value or not can both be beneficial to traders, depending on how one plans to trade.
How to Trade Cryptocurrency Futures
A future contract is one where a buyer and a seller agree to transact on a certain asset at a specific price on a specific date in the future. The price of a futures contract can be an indicator of the market sentiment with regard to an asset. However, a trader does not need to hold the future till its expiry. It can be bought and sold at any time.
Futures give traders leverage, which allows them to trade larger quantities of an asset than they would have been able to if they had to pay cash to buy that asset.
The amount of leverage depends on the broker or platform that the trader uses. For example, if a bitcoin is trading at $40,000, then a trader would have to pay $200,000 to buy 5 bitcoins.
With a bitcoin futures contract, a 5-bitcoin lot can be bought for a lot less than $200,000. Then, if the price of bitcoin goes up from $40,000 to $50,000, the trader’s account will show a tidy profit of $50,000 (5 BTC X $10,000). With a bitcoin future, the return on capital put up for trading is a lot less than $200,000 and hence the return on capital jumps.
Before you get excited, you should note that if the price of bitcoin falls, then the loss would also be heavy (5 times the price fall). So, derivative contracts come with their own levels of risks. Traders can buy (go long) or sell (go short) a future depending on their prediction of the direction of price movement. They can also take a position and then hedge it using something known as options.
How to Trade Cryptocurrency
An option contract is a contract to transact a specific asset at a specific price on a specific future date. However, as the name suggests, an option gives the contract holder the “option” and not the obligation to buy the asset in the future at the agreed price. If the option holder chooses not to exercise the option, then it expires worthless. An option seller, however, does not enjoy the freedom of choice. An option seller has to pay up or provide delivery of the underlying asset that its sold option is linked to.
For example, let us assume that a $45,000 BTC call option, with a lot size of 5 bitcoins, expiring on 31st December 2022 is bought by Anna for $100. If Anna buys this option, someone had to sell it to her. In fact, always remember that with derivatives, if there is a buyer of a contract, then there has to be a seller taking an opposite position. There cannot be a contract without a buyer and a seller.
Let us assume Jack sold this option. If the price of BTC is $50,000 on 31st December, then Anna has profited $50,000 as she has the option of buying 5 BTC for $45,000, which is $5,000 less than the market price. However, Jack lost out as he now has to sell 5 bitcoins at $45,000, which is less than the current market price of $50,000.
Like Call options, there are Put options that give the buyer the option to sell the underlying asset at a specific price on a specific date. Buying a call option or selling a put option is a bullish bet. You would do so if you believed that the price would either go up or hold its current level. Buying a put option or selling a call option is a bearish bet. You would do this if you thought that the price will fall or the price won’t rise.
You can combine calls and puts, buying and selling to create all sorts of strategies. You can also go long in futures and partially hedge the risk of the price falling by buying a put option.
The Option of Perpetual Contracts
There is a third type of derivative instrument known as a perpetual contract. Unlike futures and options, which have an expiry date, a perpetual contract has no expiry date. It can be held on as long as the holder continues paying a holding fee called the funding rate. Generally speaking, the difference between the price of the underlying asset and the price of its perpetual contract tends to be significant. However, it can change with time and market sentiments.
Final Thoughts: Why Trade NDCs?
The most obvious answer to why one may want to trade NDCs is the higher return. Since derivatives offer leverage, a trader can trade much more volume with a limited amount of capital. However, the losses can also be outsized, so there is risk involved. With derivatives, traders can also profit from a price fall. NDCs allow traders to create short positions. Traders can also use options to create strategies that profit if the price stays range-bound.
Some other reasons could be portfolio diversification and risk management. A trader can be long bitcoin in the cash market (by paying the full cash amount for the bitcoin held) and then hedge that position by buying options to limit losses in case of a price fall. Various other strategies can be created to earn some extra income in addition to holding a cryptocurrency long-term.
Learning about trading is a constant process with no expiry date. At Cerus Markets, we are dedicated to making traders informed and aware of the benefits and risks associated with trading NDCs. We encourage you to sign up and open an account if you believe that you are ready to start trading. We currently also have a 100% welcome bonus offer for new sign-ups. Remember – There’s always a bull market somewhere.