Futures-Spot Arbitrage Strategy: Introduction and Implementation

Introduction to Futures and Spot Markets

Spot Markets Explained

Spot markets involve the immediate exchange of physical assets or commodities, such as:

• Agricultural products (soybeans, corn)
• Cryptocurrencies (BTC, ETH)

Spot Trading Characteristics:

• Transactions settle "T+0" (immediate payment/delivery)

• Examples:

  • $10 for 2 lbs of soybeans
  • 100 ETH exchanged for 7 BTC

Futures Markets Demystified

Futures contracts standardize future-dated transactions of underlying assets. Notable examples:

Commodity Futures (DCE Exchange b2111 Contract):

• Underlying: Soybeans
• Expiry: November 2021
• Contract Size: 10 metric tons
• Margin: 5% of contract value

Crypto Futures (OKEx BTCUSDT Quarterly 1231):

• Underlying: Bitcoin
• Expiry: December 31, 2021
• Lot Size: 0.01 BTC
• Max Leverage: 125x

Key Mechanisms:

• Long positions (bullish)
• Short positions (bearish)
• Margin requirements (e.g., 500 USD collateral for 100x leveraged BTC position)

The Futures-Spot Price Relationship

Delivery Contracts

As expiration approaches, futures prices converge with spot prices due to:

• Arbitrage opportunities
• Physical settlement mechanisms

Perpetual Contracts

Maintain price parity via funding rate mechanism:

• Positive rate: Longs pay shorts
• Negative rate: Shorts pay longs

Arbitrage Strategy Framework

Core Logic:

1. Open positions when futures premium exceeds spot (spread S1)

   • Buy spot + Short futures

2. Close positions when spread narrows (S2)

   • Sell spot + Cover shorts
3. Profit Formula: S1 - S2 - Transaction Costs (F)

Example Scenario:
XEC-USDT pair with:

• 9% price spread
• 0.375% funding rate

Quantitative Implementation

System Components:

• Market Data (order books, balances)
• Execution Algorithms (strategy logic)

Key Elements:

Workflow:

1. Spread detection
2. Position opening
3. Spread monitoring
4. Position closing

Operational Considerations

Execution Challenges:

• Limit vs. market orders
• Partial order fulfillment
• API error handling (500 errors)
• Network latency issues

Risk Factors:

• Negative funding rates
• Leverage management
• AMM-specific fee structures

FAQ Section

Q: What's the minimum spread needed for profitability?
A: Must exceed transaction costs + funding payments. Typically >1.5%.

Q: How often should positions be rebalanced?
A: Depends on market volatility - typically hourly for active markets.

Q: Can this strategy be used with low-liquidity assets?
A: Higher spreads may exist, but execution risk increases substantially.

👉 Advanced arbitrage techniques
👉 Real-world case studies

*References:

• DCE Soybean Futures Contract Specs
• OKEx Perpetual Contract Documentation
• Pionex Arbitrage Strategy Guide*