What Are Derivatives?

Derivatives are financial instruments whose value is derived from an underlying asset. In crypto, this means contracts based on Bitcoin, Ethereum, or other cryptocurrencies - without necessarily owning the actual coins.

Why Trade Derivatives?

  • Leverage: Control large positions with less capital
  • Short selling: Profit from price declines
  • Hedging: Protect existing holdings
  • Capital efficiency: More trading power
  • 24/7 markets: Always open

Types of Crypto Derivatives

1. Futures Contracts

An agreement to buy or sell an asset at a predetermined price on a specific future date.

2. Perpetual Swaps

Similar to futures but with no expiration date.

3. Options

The right (not obligation) to buy or sell at a specific price.

4. Leveraged Tokens

Tokens that track leveraged exposure to an asset.

Futures Contracts Explained

How Futures Work

Example: BTC Quarterly Future

  • Current BTC spot: $70,000
  • December future: $71,500
  • You buy 1 BTC December future
  • On expiration: Settled at spot price
  • Profit/loss based on price difference

Key Futures Terms

Contract size: How much underlying per contract Tick size: Minimum price movement Expiration: When contract settles Settlement: Cash or physical delivery Mark price: Price used for liquidation calculation Funding: (Perpetuals only) Periodic payments

Futures vs Spot

FeatureSpotFutures
Own assetYesNo
ExpirationNoneYes
LeverageUsually noYes
Short sellingLimitedEasy
SettlementImmediateFuture date

Quarterly Futures

Expire every quarter (March, June, September, December):

  • Trade at premium or discount to spot
  • Premium = market expects higher prices
  • Discount = market expects lower prices
  • Settle on expiration date

Futures Pricing

Basis = Futures price - Spot price

  • Contango: Futures trade above spot (positive basis)
  • Backwardation: Futures trade below spot (negative basis)

Basis typically reflects:

  • Interest rates
  • Storage costs
  • Market sentiment
  • Supply/demand dynamics

Perpetual Swaps

What Are Perpetuals?

Perpetual swaps are futures contracts that never expire. They’re the most popular crypto derivative product.

Funding Mechanism

To keep perpetual prices close to spot, funding rates are exchanged between longs and shorts:

  • Positive funding: Longs pay shorts (perpetual trades above spot)
  • Negative funding: Shorts pay longs (perpetual trades below spot)
  • Frequency: Usually every 8 hours

Funding Rate Example

Scenario:

  • Your position: 1 BTC long ($70,000)
  • Funding rate: 0.01% (positive)
  • You pay: $7 every 8 hours
  • Daily cost: $21

Over time, this adds up significantly.

Trading Perpetuals

Advantages:

  • No expiration management
  • High liquidity
  • Continuous trading

Disadvantages:

  • Funding costs (or income)
  • Can diverge from spot temporarily
  • More complex than spot

Options Trading

Options Basics

Call option: Right to buy at strike price Put option: Right to sell at strike price Strike price: Price at which you can exercise Expiration: When option expires Premium: Cost to buy the option

Call Options Example

BTC Call Option:

  • Spot price: $70,000
  • Strike price: $75,000
  • Premium: $2,000
  • Expiration: 30 days

Scenarios at expiration:

  • BTC at $80,000: Profit = ($80,000 - $75,000) - $2,000 = $3,000
  • BTC at $75,000: Loss = $2,000 (premium)
  • BTC at $70,000: Loss = $2,000 (option worthless)

Maximum loss: Premium paid ($2,000) Maximum gain: Unlimited (price can go up indefinitely)

Put Options Example

BTC Put Option:

  • Spot price: $70,000
  • Strike price: $65,000
  • Premium: $1,500
  • Expiration: 30 days

Scenarios at expiration:

  • BTC at $60,000: Profit = ($65,000 - $60,000) - $1,500 = $3,500
  • BTC at $65,000: Loss = $1,500 (premium)
  • BTC at $70,000: Loss = $1,500 (option worthless)

Options Terminology

In-the-money (ITM): Option has intrinsic value At-the-money (ATM): Strike ≈ current price Out-of-the-money (OTM): No intrinsic value

Intrinsic value: Real value if exercised now Time value: Extra value from time until expiration IV (Implied Volatility): Market’s expected volatility

Options Strategies

Covered Call:

  • Own 1 BTC
  • Sell call option
  • Collect premium
  • Cap upside, reduce downside

Protective Put:

  • Own 1 BTC
  • Buy put option
  • Insurance against drop
  • Keep unlimited upside

Straddle:

  • Buy call and put at same strike
  • Profit from big move in either direction
  • Lose if price stays flat

Leveraged Tokens

What Are Leveraged Tokens?

Tokens that provide leveraged exposure without managing margin:

  • 3X Long Bitcoin (BTC3L)
  • 3X Short Bitcoin (BTC3S)

How They Work

Example: 3X Long BTC Token

  • BTC goes up 5%
  • Token goes up ~15%
  • BTC goes down 5%
  • Token goes down ~15%

Rebalancing Decay

Leveraged tokens rebalance daily, causing decay:

Example (simplified):

  • Day 1: BTC +10%, Token +30%
  • Day 2: BTC -10%, Token -30%
  • Net BTC: -1% (-10% of 110%)
  • Net Token: -9% (-30% of 130%)

This “volatility decay” erodes value over time.

Leveraged Token Best Practices

  • Short-term use only (days, not weeks)
  • Strong directional conviction
  • Understand decay mechanism
  • Don’t hold through high volatility

Risk Management for Derivatives

Position Sizing

Never risk more than 1-2% of capital per trade:

  • $10,000 portfolio = $100-200 max loss per trade
  • Size position based on stop-loss distance

Stop-Loss Discipline

Essential for leveraged products:

  • Always set before entering trade
  • Don’t move stop-loss further away
  • Accept small losses to prevent large ones

Liquidation Avoidance

  • Use lower leverage (2-5x vs 20-50x)
  • Monitor positions actively
  • Keep extra margin available
  • Use isolated margin for risky trades

Portfolio Allocation

Suggested maximum for derivatives:

  • Conservative: 5-10% of portfolio
  • Moderate: 10-20% of portfolio
  • Aggressive: 20-30% of portfolio (experienced only)

Derivatives Trading Platforms

Binance Futures

Bybit

OKX

  • Full suite of derivatives
  • Options trading
  • Professional tools
  • Read OKX Review

Deribit

  • Options specialist
  • European-style options
  • BTC and ETH focused
  • Popular with professional traders

CME Group

  • Regulated futures
  • Institutional grade
  • Cash-settled BTC futures
  • Requires brokerage account

Derivatives for Different Goals

Speculation

Use: Futures/perpetuals Why: Leverage amplifies directional bets Risk: High, can lose more than invested

Hedging

Use: Puts (protection) or short futures Why: Offset potential losses in holdings Example: Own BTC, buy put to protect downside

Income Generation

Use: Selling covered calls Why: Collect premium, cap upside Example: Own ETH, sell calls monthly

Arbitrage

Use: Spot-futures basis trading Why: Capture pricing inefficiencies Example: Long spot, short futures when basis is high

Advanced Concepts

Basis Trading

Profit from futures premium:

  1. Buy spot BTC
  2. Sell futures at premium
  3. Hold until expiration
  4. Capture the basis

Risk: Liquidation if futures premium increases significantly

Delta-Neutral Strategies

Profit regardless of direction:

  • Combined positions that cancel directional exposure
  • Profit from volatility, time decay, or funding
  • Complex, requires active management

Greeks (Options)

Delta: Price sensitivity to underlying Gamma: Rate of delta change Theta: Time decay Vega: Sensitivity to volatility

Understanding Greeks is essential for options trading.

Common Mistakes

1. Over-Leveraging

Using 50-100x leverage:

  • Liquidation on tiny moves
  • Guaranteed long-term losses
  • Stick to 2-10x maximum

2. Ignoring Funding Rates

Holding perpetuals long-term:

  • Funding compounds
  • Can erode significant capital
  • Factor into all trades

3. No Exit Plan

Entering without defining:

  • Take-profit targets
  • Stop-loss levels
  • Maximum holding time

4. Trading Without Education

Derivatives are complex:

  • Paper trade first
  • Start with smallest sizes
  • Learn from each trade

5. Emotional Trading

  • Revenge trading after losses
  • FOMO into positions
  • Refusing to take losses

Tax Implications

Derivatives can complicate taxes:

  • Gains/losses from futures
  • Options premiums and exercise
  • Mark-to-market considerations
  • Varies by jurisdiction

Recommendation: Consult tax professional

Getting Started with Derivatives

Step 1: Education First

  • Understand each product type
  • Learn risk management
  • Study successful traders

Step 2: Paper Trading

  • Use testnet/demo accounts
  • Practice without real money
  • Develop and test strategies

Step 3: Start Small

  • Minimum position sizes
  • Maximum 2-3x leverage
  • Real money, minimal risk

Step 4: Keep Records

  • Document all trades
  • Track performance metrics
  • Learn from mistakes

Step 5: Scale Gradually

  • Only after consistent results
  • Increase size slowly
  • Never increase after losses

Derivatives Trading Checklist

Before each derivatives trade:

  • Clear thesis (why this trade?)
  • Entry point defined
  • Stop-loss set
  • Take-profit target(s) set
  • Position size calculated
  • Leverage selected
  • Funding/expiration understood
  • Maximum loss accepted

Should You Trade Derivatives?

Yes, Consider If:

  • Extensive spot trading experience
  • Strong risk management habits
  • Disposable capital only
  • Educational commitment
  • Emotional discipline

No, Avoid If:

  • New to crypto trading
  • Can’t afford losses
  • Trade emotionally
  • Looking for quick riches
  • Don’t understand the products

Summary

Cryptocurrency derivatives offer powerful tools for experienced traders:

  • Futures: Fixed expiration, leverage trading
  • Perpetuals: No expiration, funding rates
  • Options: Defined risk, strategic flexibility
  • Leveraged tokens: Simple leverage, decay risk

Key principles:

  • Derivatives amplify gains AND losses
  • Risk management is non-negotiable
  • Start small, learn continuously
  • Most derivative traders lose money
  • Only trade what you can afford to lose

The goal is survival first, profits second.

Next Steps

  1. Understand Margin Trading: Foundation for derivatives
  2. Master Order Types: Essential execution skills
  3. Compare Platforms: Find best derivatives exchange
  4. Security Basics: Protect your account

Final Thought

Derivatives can be a valuable part of a trading toolkit, but they’re not for everyone. There’s no shame in sticking to spot trading. The best traders know their limits and trade accordingly.

If you decide to explore derivatives, do so with eyes wide open, capital you can lose, and a commitment to continuous learning.