Module 7: Perpetual Futures
Hedging and Basis Trades
Chapter 12 of 14 · about 6 minutes
12.1 Insurance for a long-term holder
Node had bought bitcoin as a long-term investment and had no intention of selling. But a major economic announcement was coming in two weeks, and Node was worried about a sharp drop before then.
"I don't want to sell," said Node. "Selling might trigger taxes, and I'd have to buy back later, maybe higher. Is there a way to protect myself without selling?"
"That's what derivatives were invented for," said Hash. "Chapter 1 listed hedging first, before speculation, for a reason. Let's look at how perps can reduce risk instead of adding it."
12.2 Hedging with a short perp
A hedge is a position designed to offset the risk of another position. If Node holds spot BTC, a short perp position gains when BTC falls, offsetting losses on the spot holding.
Node holds 1 BTC at $100,000 and decides to hedge half of it by shorting 0.5 BTC on a linear perp, using low leverage and enough stablecoin margin to stay far from liquidation.
| BTC moves to | Spot holding change | Short perp PnL (0.5 BTC) | Net change |
|---|---|---|---|
| $80,000 (−20%) | −$20,000 | +$10,000 | −$10,000 |
| $100,000 (flat) | $0 | $0 | $0 |
| $120,000 (+20%) | +$20,000 | −$10,000 | +$10,000 |
The hedge halves Node's exposure in both directions. Node gives up half the upside in exchange for halving the downside.
A full hedge, shorting 1 BTC against 1 BTC, would make Node's position nearly flat in dollar terms: Node keeps the bitcoin but locks in its approximate dollar value while the hedge is open.
12.3 Costs and risks of hedging
| Factor | Effect |
|---|---|
| Funding | When funding is positive, the short receives funding, which can make the hedge earn a small income. When negative, the short pays |
| Fees | Opening and closing the hedge costs trading fees (Chapter 11) |
| Margin | The short needs stablecoin margin, which must stay in the derivatives account |
| Liquidation risk | If BTC rallies hard, the short loses. With too little margin, it could be liquidated, leaving Node unhedged at the worst moment |
| Exchange risk | The hedge sits on an exchange, with all the risks from Module 1, Chapter 7 |
| Taxes | Gains and losses on the hedge may be taxed differently from the spot holding, depending on the country (Module 14) |
"So the hedge's main risk is a big rally," said Node. "The spot gains would cover it on paper, but only if the short isn't liquidated."
"Exactly," said Hash. "Hedges should use low leverage and plenty of margin. A hedge that gets liquidated isn't a hedge."
12.4 Delta and delta-neutral
Delta measures how much a position's value changes when the underlying price changes. Holding 1 BTC spot has a delta of 1 BTC. A short of 1 BTC perp has a delta of −1 BTC.
A position whose total delta is zero is delta-neutral: its value barely changes as the price moves.
| Position | Delta |
|---|---|
| 1 BTC spot | +1 |
| Short 1 BTC perp | −1 |
| Combined | 0 (delta-neutral) |
Delta-neutral positions are the basis of several strategies where the goal is to earn income from something other than price direction.
12.5 The cash-and-carry trade
The most famous delta-neutral strategy is the cash-and-carry or basis trade.
Using perps: buy spot BTC and short an equal amount of BTC perps. The position is delta-neutral. When funding is positive, which is common in crypto (Chapter 7), the short receives funding payments.
| Value | |
|---|---|
| Buy 1 BTC spot | $100,000 |
| Short 1 BTC perp, margin posted | $25,000 (4x leverage on the short) |
| Total capital used | $125,000 |
| Funding at 0.01% per 8 hours (baseline) | ~$10,950 a year |
| Yield on total capital | ~8.8% a year |
When funding is higher, the yield rises. When funding turns negative, the trade loses money until it's closed or funding recovers.
Using dated futures: buy spot and sell a quarterly future at a premium (Chapter 2). As the future converges to spot at expiry, the basis is locked in. A 2% basis over three months is roughly 8% a year, known in advance.
| Perp version | Dated futures version | |
|---|---|---|
| Income source | Funding payments | Basis convergence |
| Yield known in advance? | No, funding changes | Yes, if held to expiry |
| Flexibility | Close any time | Best held to expiry |
12.6 Risks of the basis trade
The basis trade is sometimes called "risk-free." It isn't.
| Risk | Example |
|---|---|
| Funding turns negative | The short starts paying instead of receiving |
| Liquidation of the short | A sharp rally wipes out the short's margin before the trader can move funds from spot |
| Exchange or custody failure | Funds on a failed exchange are lost or frozen (FTX in 2022) |
| Execution risk | Prices move between buying spot and opening the short |
| Capital inefficiency | Large amounts of capital earn a modest return |
| Stablecoin risk | Margin held in a stablecoin that depegs (Module 6, Chapter 8) |
Many funds run basis trades at large scale, which tends to compress funding toward the baseline over time. Some crypto products, including certain yield-bearing synthetic dollar tokens, are built on versions of this trade. Understanding the basis trade helps you evaluate where those yields come from, and what could go wrong (Module 2, Chapter 11).
12.7 Funding arbitrage
Because funding rates differ across exchanges (Chapter 7), traders can go long the perp on an exchange with low funding and short the same perp on an exchange with high funding, collecting the difference while remaining delta-neutral.
This sounds simple, but it requires capital on multiple exchanges, careful margin management on both sides, and attention to fees, and it carries the counterparty risk of two exchanges instead of one.
12.8 Hedging other exposures
Perps can hedge more than spot holdings:
Token holdings in illiquid assets. If a token you hold has no perp, a short on a correlated asset like ETH might partially hedge it, though imperfectly.
Mining income. Miners can short BTC perps to lock in the dollar value of future production (Module 6, Chapter 7).
Treasury management. Projects holding their own tokens or ETH can hedge some exposure to protect operating budgets.
Unvested tokens. Recipients of locked tokens sometimes hedge with perps, which can create selling pressure in perp markets before unlocks (Module 5, Chapter 5).
12.9 Node's decision
Node decided to hedge half of the bitcoin for two weeks, with a short at 2x leverage and plenty of stablecoin margin. Funding was positive, so the short earned a small amount each day.
The announcement came, and BTC fell 8% before recovering 3%. Node's spot holding was down 5%, but the short had gained about 2.5% of the total holding's value. Node closed the hedge afterwards.
"I didn't make money," said Node. "But I slept well for two weeks."
"That's what a hedge is for," said Hash.
12.10 Try it yourself
Using today's BTC price, calculate the outcome of a 50% hedge and a 100% hedge on 1 BTC if the price moves 15% up or down. Then look up today's funding rate on two exchanges and estimate the annual yield of a perp basis trade on each, assuming 4x leverage on the short and the capital structure in section 12.5.
Key takeaways from this chapter
- A short perp can hedge spot holdings without selling them, reducing both downside and upside.
- Hedges carry costs and risks: fees, margin needs, liquidation on rallies, exchange risk, and tax differences.
- Use low leverage and ample margin on hedges, so the hedge isn't liquidated when it matters.
- Delta measures price sensitivity; a delta-neutral position barely changes with price.
- The cash-and-carry trade buys spot and shorts perps or dated futures to earn funding or basis.
- The basis trade isn't risk-free: funding can turn negative, shorts can be liquidated, and exchanges can fail.
- Funding arbitrage and other hedges are possible but add complexity and counterparty risk.