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Eqonomics

Playing The Curve Part III: Curve Strategies

March 11, 2022

Adam Wise

Playing The Curve Part III: Curve Strategies

We have covered futures curve dynamics and yield strategies in this series, and we conclude with curve strategies. While this article has been written to stand on its own, reading the previous two will be beneficial.

Market neutral approach

A calendar spread trade involves the simultaneous buying and selling of dated futures contracts. The contracts will have different expiries but reference the same crypto. In all our examples, we will use BTC dated futures.

Profit or loss is determined by the changing relationship between the two contracts. As the trade incorporates a long and short position, the objective is to produce a net positive P&L. In most instances, one of the legs will be loss-making.

We will look at two types of trades:

  • Bull steepener
  • Bear flattener

Bull steepener

For this trade, investors will buy a longer-dated contract and sell a shorter-dated contract. The rationale is the curve in contango will become steeper.

The spread between the contracts is calculated as the longer-dated contract price less the shorter-dated contract price.

The trade is profitable if the positive spread increases. Price direction isn’t directly relevant.

Example: June BTC futures price increases more than March BTC futures price. The curve steepens, and the spread widens.

Let’s look at the numbers:

Instrument

Description

Direction

Price TD

Price TD+1

P&L

BTC/USD[220624]

June Futures

Long

$40,900

$41,400

$500

BTC/USD[220325]

March Futures

Short

$40,100

$40,400

-$300

Spread

June - March


+$800

+$1,000

$200

TD = Trade Date


Investors would have made $200 per 1 BTC exposure – the increase in the spread.

Due to the market-neutral nature of this trade, leverage can be applied to magnify gains (and, unfortunately, any losses).

When might this work?

A futures curve in contango implies bullish sentiment: BTC future price is increasing as a function of time. This trade will be profitable if positive sentiment strengthens, with the curve steepening.

Bear flattener

This can be viewed as a defensive trade. Investors expect the spread between long-dated futures prices and shorter-dated futures to tighten, while the curve is in contango.

To execute, the logic of a bull steepener is inverted:

  • Long shorter-dated future
  • Short longer-dated future


When might this work?

This will be profitable when bullish market sentiment abates. In the best-case scenario, the curve would not only flatten but move from steep contango to steep backwardation.

Example: June BTC futures price decreases more than March BTC futures price. The curve becomes backwardated.

The spread not only tightens but becomes negative.

Instrument

Description

Direction

Price TD

Price TD+1

P&L

BTC/USD[220624]

June Futures

Short

$42,400

$39,900

$2,500

BTC/USD[220325]

March Futures

Long

$41,400

$40,400

-$1,000

Spread

June - March


+$1,000

-$500

$1,500

That's all for now!

While we could write plenty more on futures curve trading, hopefully this provides a solid introduction and gets you thinking.

Related trades you may wish to explore further:

  • Calendar spreads in backwardation
  • Inter exchange spreads
  • Inter crypto spreads

Even if you are trading a limited number of crypto assets, the potential combinations (and therefore opportunities) are numerous.

Spreads offer the chance to make money in all market environments. 

Play the curve!

Get on EQONEX, try yourself, and ask questions: [email protected]

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