[Aalps Research 01] Perpetuals Intro Resources
Short Answer:
Bilateral agreements that the party on the short side is required to pay the long side a sum based on the increase in the futures price between when they enter and exit the contract (thus realizing the profit(or loss) on both sides). Meanwhile, the long side pays the short side an ongoing cash flow called the “funding rate”.
If you have 6 minutes to invest:
This 6 minute video will elegantly give you an introduction to what a Perpetual Future is.
Here is my attempt to describe the contract in simple three rules
Let’s say there’s only two participants in the market, Alice and Bob (with no fees for simplicity).
The gold futures price at t=0
is $2000
. Alice can open one long contract worth of gold by posting $500
as margin (leverage=4
). This means if the gold price doubles to $4000
, her position size also doubles to $4000
, giving her 4x
on the profit size. At the same time, her position becomes liquidatable
if the price of the futures contract falls by 25%
to $1500
.
Bob, choosing his own leverage of 5x
, can be on the other side of the contract (posting $400
as margin and opening one short
contract of gold.
(Liquidation usually happens at a level higher (10% buffer) than the example, to uphold the sanity of the positions in the overall exchange)
Instead of normal futures with expiration dates, perpetual futures don’t have a set expiration date. But what’s essentially happening is that the futures contract is roll-overed periodically with the new future price as a strick price for the next checkpoint.
| t=0 (p=$2000) | | Rolled-over Contract Spec | | t=1 (p=$2500) | | Rolled-over Contract Spec | … | | --- | --- | --- | --- | --- | --- | --- | --- | | Alice ($2000 long) | pnl: 0 | “Strike Price”: $2000 | | Alice ($2000 long) | pnl: +$500 (2500-2000) → Added to margin | “Strike Price”: $2500 | | | Bob ($2000 short) | pnl: 0 | Expiration : t=1 | | Bob ($2000 short) | pnl: -$500 → Deducted from Margin | Expiration : t=2 | |
Thus, the pnl is reflected in the margin every instance the futures is rolled over. To be exact, this roll-over is happening continuously on most perpetual futures platform. Thus, the pnl is calculated every second and is reflected in the calculation of your margin (and hence whether your position is subject to liquidation or not).
Now, you may ask, “wait.. then, there when does the underlying benchmark price ever come in? how does the futures contract ever trace the underlying’s price?”
Here comes the funding rate…