Swaps and Spot Basis | Supplementary Material

Alright guys, what's going on? This is Ryan with blockroots and in this video we're going to be talking about futures, premium and discount. So we did another video on roadmaps or in roadmaps on futures where we talked about contango and backwardation. And you know the reasoning for this when it comes to cost to carry interest and opportunity costs and something like supply shock with backwardation. But in this video we're primarily going to be concerned with perpetual swaps. What we can take from identifying either a premium or a discount. So a premium is when the current futures prices are trading above the spot price so they're more expensive. So over time this would be referred to as a marketing contango. This is also known as a negative basis. So the basis is the spot price minus the futures. Now to the opposite effect, a discount is when the futures prices are trading below the spot price. So over time this would be referred to as a market in backwardation. So with the perpetual swaps this is just a, a normal event on the exchange. Right, because there's a large amount of leverage used on exchanges like BYBIT and Bitmex. This is essentially more fuel for any fire. And when traders are aggressively lifting the offer on bybit for example, the futures price or the per price will be above the spot price. Okay. Because there's essentially more buying power on the futures exchange. The same can be said when the market is selling off. All right. On the futures exchange what we'll see is that the market will be trading at a discount with respect to the spot exchange. So the futures price will fall below the spot price. So there's many times when these two things can swing far from each other. So why is this useful? Well one, it's useful because it's used to directly calculate the funding. So when there is a situation where the premium has been high for a prolonged period of time and longs are aggressively opening up, or in the popular trade, let's say has been long, what will likely have because of that is a positive funding rate. And if you're long currently and the funding rate is positive, you have to pay shorts. If you're not currently short and you're not in position and you open up a short, you'll get paid. So when a long closes out to not have to pay the funding, that moves the price back down to the underlying spot price. And when a short opens up again, this is essentially, this is selling power and this moves price back down as well. So when the prices of the spot price or the spot instruments become detached from the futures contract, or in this case the perpetual swaps, then the funding rate is used to keep these two in line. It's a mechanism that incentivizes traders to open up positions and close them out in order to rather in an effort to keep these two prices in line. So at any given point, this can give us an idea of what side of the market is aggressively being hit. And this is also very useful when we consider whether or not the market has any new participants in it. So if, for example, we don't see a ton of new retail interest and most of the trading is being done on Bitmex and Bitmex and the derivatives exchanges lead the market, then the positioning on those exchanges will likely determine the near term direction for the entire market. So when we see that say for example, offers are aggressively being lifted, such as longs are opening up aggressively at market and the price is not moving, this is similar to the idea of cumulative volume delta divergences when we talk about order flow, in that the heavier hand is keeping price from moving. So in cases where there is a high premium, okay, and the funding rate is positive, it's likely that this along with maybe some evidence that the open interest has been increasing, this is good evidence for a case to be made around potentially longs being offsides or crowded in the wrong position. Right? What happens when you have crowded setups or areas of the market where maybe longs are crowded or shorts are crowded? Well, if shorts are crowded in position, then you have squeezes, right? So when shorts are crowded and they're pressured, they have to all close out at once and go from the door or go through the door, and that's when you have a squeeze upward. So the same thing can be said for longs. When they're crowded in position, they likely have a lot of stops relatively close to their position. And when they're pressured by any type of downward pressure, they have to close out at once. And that's when we have these liquidation events. And a lot of the times in certain market conditions when there's again no new retail coming in and the market is ranging, Bitcoin likes to move off of liquidation. So identifying where the crowded positions are and who's potentially offside is a major benefit. So again, this used with other information such as say we are approaching a higher time frame resistance, say we are grinding at support after being rejected from resistance multiple times. If we see that the funding rate is still positive and there is still a decent sized premium, this gives us Some inclination rather that the longs are still crowded in position and potentially we have further to fall. Now the premium and the discount are going to give you again insight into what side of the market is aggressively being hit. So we could also identify maybe when this is beginning to shift, when the premium, premium is also going from negative to positive. And as you can imagine, this can be particularly useful when we're identifying maybe what side the market is switching from. So if we see that, say for example, there was a very negative or rather a decent sized discount and the market was moving sideways for a long period of time and there was a decent sized discount like this will go over here and we'll see that at the bottom down here, there was actually a decent discount where the spot price was above the perpetual swap price. So if I zoom out, you'll see that the discount is indicated by this dark line below the funding line. All right, the dark line on this Neobutan indicator, this is the premium index and the funding index, the indicator's name is actually the Bimx Funding and Premium index. So the premium index is used to calculate the funding rate. But in this case, the perpetual swaps are trading at a discount to the spot price. So if you zoom in, you'll see that the perpetual swaps are indicated by the orange line and the spot price is indicated by the blue line. So now the orange line is below the blue line. You can barely see it on this. I'm going to go on to a lower time frame chart to show you that in a second. But you can see with this indicator right here that the market was trading at a discount. Right? The futures prices were trading at a discount and then this began to shift. So if we actually go on to a lower time frame, what we would see is that the discount begins to decrease, all right, and start to show favor on side of buyers beginning to pressure. Okay? So the discount is beginning to disappear, all right, leading to eventually a premium, but showing that the sides of the market were beginning to shift. So any aggressive shorts over here were likely going to be found offsides if they hung onto their positions. And, you know, we all know what happened after that. So when we zoom in, you can actually see what I was referring to just briefly. So the black line is the Bitcoin US dollar index. So the US dollar index is what Bitmax uses, okay? They have their own index, Bybit has their own index, and it's essentially a compilation of multiple spot exchanges, all right, or oracles, that's what they're referred to. They're referred to as oracles. So this is what the futures price is essentially supposed to stay in line with. But you can see that the orange line, which is the perpetual swap, is at times above and below. So again, in the case when it's above, the market is trading at a premium. In the case when it's below, the market is trading at a discount. So when the market moves aggressively up, this is going to occur. So you're going to have the futures price above the spot price and when it's moving aggressively down, the same can be said. But this again is particularly useful when the market is moving sideways. Okay, when we have something like this over here, so for example, we look over here, this was multiple rejections at the top, we saw clear signs and divergence in order flow. All right, longs were aggressively lifting the offer. You can see that they're still crowded. There was still that premium. Over here, the funding rate was still positive. This begins to shift. But this is just the amount of evidence that we need. Along with, like I said, some other further confirming information, stuff that we go over in separate videos, just the type of stuff that you want to look for to identify maybe who's already trapped in position. And if longs are already trapped, okay, and the funding rate is positive and sentiment is extremely bullish, just add all these up, who is left alone? Right. The only thing left to do when the market is crowded long is for longs to close out. So this is just a case of how we'll use the premium or the discount that exists between the spot price and between the futures price as a way of substantiating a case for potential near term directional movement. So whether or not we're talking about a breakdown or a squeeze upper. Alright, so if you want to look at this on the actual exchange, if you go on to Bybit, you can go on to contract details and you can see when the last traded price, which is the futures contract, is trading either above or below the index price. So when it's trading above the index price, that means that it's trading at a premium. When it's trading below the index price, that means it's trading at a discount. So again, you use this along with other information as well. You're not just going to be looking at whether or not the market is trading at a premium or a discount. But again, after a major move has occurred and we see signs of weakness, we see signs of again where the potential heavier hand is. So if we have a divergence in cumulative volume delta okay, if we have decreases in volume, all right, extreme bullish sentiment, and we already have this premium in this case or this positive funding rate and price is really doing nothing to move upward, this can give us insight into the fact that the market is already crowded long, okay? And this premium is a product of that. So the only thing left to do for crowded longs is to close out. And again, when they go for the door all at once, then that's when you have these, these large spills, right? So spills occur to the upside into the downside though, right? So down here, all right, if we look at, again, if we look at this, this indicator, we see that the discount was obvious, alright? So the discount was obvious. This line below here, all right, being negative in this case, when all of these shorts are crowded in a position and they have to go for the door, then they have a squeeze or they cause a squeeze upward. So you need to take this in consideration with market structure, okay, with certain context, okay? Say we've been rejected multiple times. Like this structure up here, we've been rejected. Price is starting to show weakening price action, okay? Volume is decreasing. You have everyone calling in this case for a newer high. But you know, it's already shown that the funding is largely positive and that the premium is pretty substantial. Who else is going to open up longs at this point? And again, same same can be said for the downside, right? So when the discount is quite obvious and there's a large discount and the funding is very negative, okay, this shows that the other side of the market has gotten very crowded, all right? Now Bitcoin is either an asset that trends tremendously, okay, when new interest is coming into the market, or it's an asset that spends a lot of time going from range breakout to range to range breakout to range. And these breakouts and these large moves tend to occur because of liquidations, okay? So we go from liquidation to range, liquidation to range. So identifying where trap traders are, okay, and where there might be certain areas where one side of the market is crowded versus another, okay? This is a way that we can potentially get ourselves in position with the correct side in this case. So what do I look for? I look for again, positive funding, high premium, or a very negative funding and very substantial discount, okay? With consideration, with consideration of other information as well. So never just on its own, but that's premium, that's discount. So again, just a quick recap. So premium is when the futures price is above the spot price. This means that there's a negative basis And a discount is again when the futures price is trading below the spot price. All right, guys, so that's that. This is Ryan with block roots. As always, exercise proper risk management and trade effectively.