Perpetual Futures vs. Traditional Futures Contracts: What's the Difference

Perpetual contracts are similar to traditional futures contracts, but there is one key difference. The core point is that perpetual contracts have no expiration or settlement date.

For example, let's think about a futures contract on a physical commodity such as gold or oil. In traditional futures markets, these contracts require the actual delivery of the gold or oil on the expiration date. In other words, when the futures contract expires, the physical commodity must be delivered according to the terms of the contract.

Because someone actually holds the commodity in this way, the contract incurs a "cost of carry." In addition, the commodity's price can vary depending on the gap between the current time of the contract and the future settlement date. As that gap widens, the contract's cost of carry rises, the potential futures price becomes more uncertain, and the potential price gap between the spot market and the traditional futures market grows larger.

Perpetual contracts use futures contracts (notably, without delivering the actual commodity) while tracking movements in the spot market, in order to narrow the price gap between the futures price and the mark price. Perpetual contracts are a major evolution of traditional futures contracts, and they can maintain a long-term or even permanent position relative to the spot price.

Funding fees are charged to ensure that the perpetual contract and the mark price converge over the long term. Here are some key concepts traders should know about perpetual contracts.

• Mark price: To prevent market manipulation and keep the perpetual contract in line with the spot price, the mark price is used to calculate every trader's unrealized profit and loss.
• Initial and maintenance margin: Traders should be familiar with the initial and maintenance margin levels, and especially with the maintenance margin level at which automatic liquidation occurs. To avoid paying the high fees that come with automatic liquidation, it is strongly recommended to close your position while you still have sufficient maintenance margin.
• Funding fee: This is a payment exchanged between all longs and shorts in the perpetual futures market. The funding rate determines who pays and who receives. If the funding rate is positive, longs pay shorts. If the funding rate is negative, shorts pay longs.
• Risk: Unlike the spot market, the futures market lets traders place large orders that are not fully covered by their initial collateral. This is called "margin trading." As markets have become more technologically advanced, the amount of available margin has increased.

That wraps up our look at the differences between perpetual contracts and traditional futures contracts. The key is whether there is an expiration or contract date, and whether the actual commodity is delivered. For more details on perpetual futures contracts, please check out the article below.

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