Contango: Your Chance for a Low-Risk Profit

Okay, low risk and Bitcoin don’t go together at all. If you look at the price trend of the cryptocurrency, it is shaped by high volatility and the large jumps that come with it. But what if there is a trading strategy that allows you to make an investment in Bitcoin and know in advance how much profit you will make? The basis for this opportunity is called contango. Learn how you can take advantage of this situation with Bitcoin and other cryptocurrencies on the Binance trading platform.

As with all arbitrage trading opportunities, taking advantage of contango is about leveraging the price difference of two related markets. In this case, it is about the price difference of the spot and futures price of an asset. If you don’t know exactly how trading with futures contracts works, I highly recommend reading my article about it.

Futures contracts for dummies – a simple explanation

Contango: The correlation of spot and futures market

Investors can trade assets and futures of assets completely separately from one another. However, the prices are linked to each other in the sense that the spot price of an asset forms the basis for the price of its futures.

For example, if the Bitcoin price is $60,000, investors certainly do not expect a price of $10,000 in three months. Consequently, investors form their expectations based on the current market value of BTC. A price of $62,000 or $58,000 in the future would be more realistic.

As already described in my article about trading futures contracts, the spot and futures rates continue to converge until the delivery date. On delivery, the two prices are inevitably the same.

Example of how the correlation between futures and spot price looks like.  The Bitcoin futures delivery 12/31 trades for $62,000 on 10/15. At the same time, the bitcoin spot price is $60,000. Over the duration until 12/31, the two curves get closer and closer. Thus, on 11/23, the curves are only $1,000 apart, as opposed to $2,000 at the beginning. On the delivery date of 12/31, both prices are equal. This correlation is called contango.
Trend example of bitcoin spot and futures prices

What is contango and how to benefit from it?

The opportunity for your profit is based on the following facts:

  • In a bull market, the futures price is higher than the spot price.
  • On the delivery date, futures have the same value as the underlying asset.

This price situation is called contango and it can be leveraged by applying the Cash And Carry arbitrage trading strategy. Investors profit from it by shorting futures contracts (Short Selling? Long Buying? Finally a Simple Explanation). In addition to short selling futures, they simultaneously buy the underlying asset. The investor thus buys an asset in the cash market («cash») and carries it until the delivery date of the shorted futures contract («carry»). If the price of the asset falls, its futures price also falls. Consequently, the investor makes a loss on his purchased asset, but a profit on his futures investment. In turn, if the price of the asset rises, its futures price also rises. Thus, the investor makes a profit on the purchased asset and a loss on its futures investment: the investment is in a neutral position.

You buy an asset and at the same time you sell a borrowed one at a higher price.

Contango with commodities

In my post about futures trading, I wrote about John and the coffee vendor. John decides to enter into a futures contract to prevent having to store the coffee beans until delivery. In exchange, he is willing to pay a little more per kilogram of coffee.

If John wants to take advantage of the contango price situation, he has to accept storage costs. On the one hand, he buys coffee beans and, at the same time, he sells a futures contract to Robert, his colleague, who also owns a store. Since John has to pay for the storage costs, his profit is also lower, which is therefore calculated at the time the goods are handed over to Robert as:

Profit = roberts_payment – coffee_cost – storage_cost

When trading stocks and cryptocurrencies, there are no storage costs. In return, trading fees have to be taken into account, which are many times lower.

A simple example of arbitrage trading with contango

Warren read an exciting blog post about the contango price situation. Now he wants to profit from the price difference of the Bitcoin spot and futures market. The two markets have the following parameters on 10/15/2021:

  • Spot market: $60,000
  • Futures: $62,000
  • Futures delivery date: 12/31/2021

Warren buys 1 BTC and goes short with 1 BTC futures. As collateral, he deposits the bitcoin bought on the spot market. The bitcoin is worth less than the shorted futures contract. But since the futures market only requires a collateral of at least 50%, the purchased Bitcoin is completely sufficient.

Over the following months until the end of the year, the price runs according to the diagram above. That is, the two prices start with a difference of $2,000 and both values meet on December 31 at $60,300. Warren set up an Excel spreadsheet in which he tracked his profit.

Development of the profit when investing in spot and futures market simultaneously in a contango price situation. The table shows an initial futures value of $62,000 on 10/15. In the meantime, the price drops below $60,000 and then ends on 12/31. At $60,300 the spot price, in turn, starts at 60,000 on 10/15, drops in the meantime to $58,000 and is then also at $60,300 on 12/31. The initial difference of $2,000 is the profit earned with the trading strategy.

The Excel table shows that the profit and loss of the two markets always balance each other out. In addition, the convergence of the two prices shows up as a profit for Warren. Whereas on 10/15 there was a difference of $2,000, on 11/30 the difference is only $800.

On December 31, the futures contract expires and Warren has to deliver. Accordingly, he «hands over» his Bitcoin bought on the spot market and collects the $2,000. Warren has thus realized a return of 3.33% within 3 months. Projected over the year, this results in an interest rate of 13.33%.

Unlike the stock markets, cryptocurrencies do not require to trade entire units. Therefore, Warren could have traded only a fraction of a Bitcoin. With a trading volume of 0.5 BTC, this would result in a profit of $1,000, which of course would still correspond to a return of 3.33%.

In addition, Warren has the opportunity to liquidate the investment at an early stage and take the profit. However, if he does not need the money and does not see a better opportunity, it is pointless to abandon the investment due to the low risk associated with taking advantage of the contango price situation.

Risks and side effects

Yes, the headline of the article is catchy and makes you sit up and take notice. I write about low risk and profit which is indeed the case when used correctly. In principle, there is no market price risk. The investor is only exposed to a price fluctuation between the time of the purchase in the spot market and shorting in the futures market. In the following chapter, my example shows that I was exposed to exactly such a fluctuation (because I dawdled!). Fortunately, the fluctuation worked out in my favor.

Hands-on: Leverage contango on Binance

Of course, I have already leveraged the correlation of the futures and spot market price. The following guide should help you to find your way around as well. Since I spend a lot of time on Binance for advanced trading, the screenshots were taken there.

Binance Logo bestehend aus dem Binance (BNB) Icon und Binance ausgeschrieben.

Create your account on Binance here and get 10% discount on all trading fees.

1. Compare both markets

To check the potential return, I usually compare the current price value of the spot and futures market.

Comparison of the two markets BTC Futures Quarterly 1231 and BTC spot market. BTC futures are trading for USD 65,543.80 at this time. BTC itself is offered by Binance in the spot market for USDT 63,366.65. BTC futures are trading higher and thus the two markets are in contango.
Screenshot created on Binance

The screenshot on the left shows that BTC futures are trading at a price of $65,534.8. The one on the right shows the spot market of Bitcoin. Its price at the time the screenshot was taken was 63’366.65 USDT. Neglecting the trading fees, this results in a potential return of 3.42%.

2. Purchase of bitcoin and transfer it to the futures wallet

In the spot market you buy Bitcoin for the value you want to invest. The following screenshot shows a purchase for 100 USDT at the current market value.

Purchase view of BTC on Binance. The screenshot shows a purchase of BTC for 100 USDT at the current market price.
Screenshot created on Binance spot market

In order to be able to trade with futures and benefit from the contango price situation, you have to deposit a collateral as described above. The BTC bought with the 100 USDT should form this collateral. For this reason, you now switch to Binance Futures -> Coin-M Delivery. There you click on the button «Transfer», which opens a popup window.

After buying BTC in the spot market, it is recommended to transfer to the futures market and open a short position quickly. The market moves in the meantime and the purchased BTC are exposed to its fluctuations without protection. A neutral position is reached only after you have placed the order in the futures market.

Transfer window on Binance Futures. The screenshot shows that 0.00157392 BTC can be transferred from the spot wallet to the futures wallet.
Screenshot created on Binance Futures Coin-M Delivery market

Select the amount of BTC you have previously purchased in the spot market and click «Confirm».

3. Adjust leverage and short futures

Binance offers to trade futures with 125 times leverage 🤯. Do yourself a favor and don’t do that. In this example we don’t want to use any leverage at all in order to trade with minimal risk. Therefore, click on the button above the purchase form (framed in golden in the screenshot) to adjust the leverage. In the popup window that opens, reduce it to 1x.

View of Binance futures purchase form. Above the form you can adjust the leverage. Currently this is set to 4x on the recording.
Popup window on which the lever can be adjusted. On the image it is set to 1. However, it is apparent that a lever of up to 125x would be possible.

Now you are ready to short BTC futures. To do so, select «100%» in the form which overlays the graph and click «Sell/Short».

Form for selling/shorting BTC futures. In the screenshot it can be seen that 100% of the BTC present in the wallet is used to sell futures.

Congratulations, your investment is in the contango price situation. Now it’s time to wait and collect your profit.

4. Monitor futures wallet

After you have placed your short sale, go to your Futures Wallet -> Coin-M Futures. There you will see the total value of your assets: your collateral + your shorted futures.

Futures Wallet on Binance. The Coin-M Futures Wallet has a total value of $100.99. The Total Unrealized Gain with Futures has a gain of 2 cents after entering the contango price situation.
Screenshot created on Binance Futures Wallet.

It is important that you always look at the total value (framed in golden in the screenshot). In my example the value of «Total Unrealized PNL» is positive. However, it can very well be that this slips extremely into the negative. For example, this is the case when the price of Bitcoin increases enormously and thus depresses the value of your futures short position. But this is not tragic, because you still have Bitcoin in your wallet, which profit from the price increase.

I took the screenshot right after shorting BTC futures. You can see that the value is higher than the 100 USDT invested before. This is probably due to the fact that the BTC price has increased between buying on the spot market and short selling on the futures market.

About ten days after my investment, my futures wallet shows the following parameters.

Screenshot of the Futures Wallet on 03.11.2021. The screenshot shows a total value of $101.98. As Total Unrealized PNL a value of $5.41 is shown. The BTC Wallet Balance shows a value of $96.57. Thus, a profit of $1 was made by exploiting the contango price situation.
Screenshot created on Binance Futures Wallet 10 days after my investment.

The image shows that my futures investment has earned me a profit of $5.41. At the same time, the BTC deposited as collateral has a value of only $96.97. Compared to the previous screenshot, you can see that taking advantage of the contango price situation generated a profit of about $1 so far. In fact, the total value is now $101.98 compared to $100.99 ten days earlier. By the delivery date, the investment should generate a return of about $3 according to the pre-calculation. At the end of the year, I will update my findings in this post. Stay curious!

Cash and carry arbitrage is not the only arbitrage trading strategy. Especially with cryptocurrency it is worthwhile to look into perpetual futures spot arbitrage where it is all about the so-called funding rate: Funding Rate: Is This Free Money?

Update 01/05/22

5 days ago my position expired and I intentionally did nothing. On December 30, I received an email from Binance informing me of the expiring contract.

E-Mail von Binance darüber, das ich einen offene
Email from Binance

Even after the email, I did nothing. And there you go, Binance liquidated the position at 09:01 am on the settlement date (12/31) and credited me the earnings.

Positions in the order book after liquidation of the futures position. Profit: 0.00059714 BTC. Commission: -0.00000106 BTC.
Positions of liquidation

The screenshot from the order book shows a positive BTC profit. It should be noted that this may well be negative. In this case, the Bitcoin price would have risen in the meantime. The profit thus would have been made through the rising Bitcoin price instead of through the short position.

It is important to sell BTC quickly after liquidation, as the asset is no longer in the neutral contango position.