A popular question in the cryptocurrency ecosystem is whether the expiry of futures contracts on exchanges such as the Chicago Mercantile Exchange (CME) has an impact on the price of Bitcoin (BTC). The short answer is yes. Historically, the data shows that on the day prior to the settlement of futures contracts, a BTC price drop of approximately 2% for both median and average is recorded. In this article, we shall examine the kind of effect futures contract settlement dates have on Bitcoin’s price. 

What Are Futures Contracts?

Futures contracts are legal agreements to either buy or sell a particular asset or security at a predetermined price on a predetermined date in the future. They are derivative financial contracts imposing an obligation to transact an asset; on one hand, the party who purchases a futures contract undertakes an obligation to buy and receive the underlying asset on the date of expiry while on the other hand, the party who sells a futures contract takes on the obligation to provide and deliver the underlying asset on the date of expiry.

Futures contracts are also known as a derivative because it derives their value from an underlying asset. Essentially, investors buy the right to sell or buy the underlying asset later at a pre-set price. Investors either purchase the right to sell seeking and expecting to profit from a price increase or purchase the right to sell expecting to profit from a price drop of the underlying asset. 

Futures contracts are sometimes compared to forwards contracts which are similar types of agreements, only differing in the sense that while futures are standardized, forwards are traded over the counter (OTC) and bear customizable terms that are negotiated by the parties. Futures contracts, as opposed to forwards, retain the same terms regardless of the identity of the counterparty. 

Who Uses Futures Contracts?

Futures contracts, also referred to as ‘futures’ are utilized by two kinds of market participants: hedgers and speculators. 

Hedgers

Hedgers are businesses or individuals who use futures to protect themselves and their investments against volatile price movements in the underlying commodity. A good illustration of hedging would be a tomato farmer and a tomato canner; the former would want protection from dropping prices while the latter would want protection from rising prices. Consequently, to mitigate the risk the farmer would buy the right to sell the tomatoes at a later date for a predetermined price while the canner would buy the right to purchase the tomatoes at a later date for a predetermined price. Each party takes a side in the contract and they both hedge their exposure to the price volatility of the commodities. 

Speculators

Speculators are independent traders and investors who trade futures in much the same way that they would stocks or bonds. Since futures contracts are generally liquid and can be transacted up to the time of expiration, they are attractive to speculators who do not own the underlying asset, nor do they seek to. Speculators can trade futures to express an opinion about- and possibly profit from- the direction of the market for a commodity. Prior to the expiration of the futures, these speculators will then buy or sell an offsetting futures position to remove any obligation to the actual commodity. 

Cryptocurrency Futures Contracts

Cryptocurrency futures are contracts between two investors betting on the future price of a digital asset. Crypto futures allow investors to gain exposure to certain cryptocurrencies without having to outright purchase them. They are akin to traditional futures contracts for stocks or commodities as they allow an investor to bet on the price movement of an underlying asset. Cryptocurrency futures are traded on the Chicago Mercantile Exchange (CME) and on cryptocurrency exchanges. 

In December 2017, the first Bitcoin futures contracts were listed on the Chicago Board Options Exchange (Cboe), however, they were soon discontinued. The CME also introduced Bitcoin futures in the same month 2017, and its product has grown to become a huge part of the cryptocurrency trading sphere. BTC futures are based on the CME CF Bitcoin Reference contracts, trade on the Globex electronic trading platform, and are settled in cash. 

Mechanism of Crypto Futures Trading

A crypto futures contract is composed of three main parts: units per contract, leverage, and the expiration date.

Units per Contract

This determines the value of each contract’s worth of underlying value and varies depending on the platform. For instance, one Bitcoin futures contract on CME equals 5 BTC denominated in USD while one Bitcoin futures contract on Deribit is equal to $10 worth of BTC.

Leverage

Exchanges allow users to increase their potential gains on their futures bet by lending them capital to increase the size of their trades. Leverage rates also vary greatly according to platforms with Kraken, for instance, allowing users to boost their trades by up to 50X while Binance offers up to 125X leverage. Leverage is the crucial feature of margin trading, and it is important to note that while it can be used to supercharge potential profits, the risks are parallel to the leverage involved.

Expiration Date

The expiration date of a BTC futures contract is the date when it must be settled; one party has to buy and the other has to sell at the predetermined price. Notably, however, traders can sell their futures contracts to other parties prior to the settlement date if they so wish.

Expiration-day Effects of BTC Futures on Price

Expiration-day effects have been found to exist across various stock markets and typically refer to three things: increased trading volume of the underlying asset on expiration day, increased price volatility on expiration day, and price reversals after the expiration date. The CME has the largest volume of futures contracts traded. Each contract is comprised of 5 BTC and the maximum position is set at 4,000 contracts. These derivative contracts are cash-settled on the last Friday of each month at 4 PM GMT. 

When traders wish to hold on to their futures contracts even when they are expiring, they roll over—a feat generally achieved by selling the old contract and purchasing a new one at the current spot price. It is this rolling over of contracts that affect the price of BTC when futures contracts are settled. As the date of contract expiry approaches, in many cases trading volume with increase and the underlying asset will experience abnormal volatility. 

A potential explanation for this increased volume of trade is that investors are rolling over their futures contracts, and this usually happens shortly before the initial date of expiry. Another explanation is that short-term traders usually exit before the expiry of the contracts so as to collect the accrued profits off the price fluctuations, in addition to avoiding having to actually buy or sell the underlying digital assets. 

When trading volume surges in the lead-up to expiration dates, the increased volatility will inevitably affect the underlying BTC and influence future prices particularly when the market is awash with speculators. Research has indeed shown that BTC price falls an average of 2.2% in the days leading up to the expiration date which is significant when compared with the average on a random day which is 0.06%.

It is statistically highly unlikely that these price falls in advance of CME settlement are caused by mere coincidence, and some people have speculated that it is price manipulation by institutional investors. However, the figures do not necessarily point to ‘deliberate manipulation’ nor do they suggest conclusively that it is only a result of investors’ hedging strategies.