How To Arbitrage From Funding Fees Futures/Spot Hedging

Funding rate arbitrage is a strategy where you hedge a Futures market investment through Spot market trading. For instance, if you hold a short position in the Futures market, you can purchase assets in the Spot market of equal value to safeguard your investment from significant price fluctuations while also earning funding fees.

 

1. Why Use Funding Fee Arbitrage?

1.1 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. While in a negative rate, it's the reverse.

 

 

1.2 Lower Risk: when you simultaneously place a buy order in the Spot market and go short in the Futures market with an equivalent value, you effectively shield your investment from market fluctuations, mitigating the risks posed by adverse price movements. This method effectively acts as a hedge, safeguarding your investments through Futures trading.

 

1.3 Stable Income: normally, the funding rate remains positive, allowing you to continuously accumulate funding fees by maintaining a short position in the Futures market paired with a corresponding buy order in the Spot market. Funding fee arbitrage caters to traders aiming to diversify their investments and pursue stable, long-term growth.

 

2. How to Arbitrage from Funding Fees?

Step 1: Select an arbitrage portfolio with the highest annual yield

 

The funding fee is settled 3 times daily, and profit = position value * funding rate. With an equivalent position value, higher funding rates result in more significant arbitrage opportunities. Check out the funding rates of different contracts.

 

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

 

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

 

Step 3: Await funding settlement.

 

After the settlement of funding fees, you can close your positions to reap arbitrage profits.

For instance:

 

Suppose John finds the current funding rate is at a high point, an ideal time for funding fee arbitrage. John has 12,000 USDT, and the current price of XLM is 0.12 USDT. He then:

 

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

 

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

 

See the screenshot below for more details:

 

 

3. Regardless of market movements, gains and losses on XLM Spot and contract positions offset each other, substantially minimizing the risk of losing the principal.

 

4. Assuming the funding rate remains constant at 0.23% after 3 settlements, then:

 

Single profit is 50,000 * 0.12 * 0.23% = 13.8 USDT

Annualized return is 0.23% * 3 * 365 = 251.85% 

 

5. Once the funding rate reaches your intended level or falls below it, you can close your position to reap arbitrage profits.

 

You can also increase the leverage and replicate the actions described above to maximize the utilization of the principal, ensuring that the value of the Spot order matches that of the contract.

 

3. Notice

3.1 Liquidation Risks

To enhance risk management, it is advisable to use lower leverage and implement Take Profit and Stop Loss orders for your positions.

 

3.2 Keep the Same Value

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

 

3.3 Funding Rate

Please pay attention to the changes in the funding rate and consider closing your positions when your expected returns are achieved.

 

You have the option to review the funding history for contracts on CoinCatch, including both USDT-Margined and COIN-Margined perpetual contracts.

 

No matter which contracts you're using, whether they are based on USDT or COIN, you can benefit from their funding fees through arbitrage. The arbitrage of COIN-Margined contracts is much easier. All you need to do is hold the same coin and open a short position in the corresponding contract with the same value and 1x leverage to perform the arbitrage strategy.