How Does High Leverage in Cash-Settled Contracts Increase Liquidation Risk?
High leverage increases liquidation risk because it dramatically reduces the margin cushion available to absorb losses from adverse price movements. A small percentage move against the position can cause the account equity to fall below the maintenance margin level, triggering an automatic liquidation.
Since cash-settled contracts are typically highly leveraged, traders are more susceptible to being wiped out by short-term volatility.
Glossar
High Leverage
Amplification ⎊ High leverage, within cryptocurrency and derivatives markets, fundamentally alters risk-reward profiles by enabling a smaller capital outlay to control a larger notional exposure.
Account Equity
Balance ⎊ Account equity represents the total capital an investor holds within a trading account, encompassing both settled funds and the current market value of all open positions.
Insurance Fund
Fund ⎊ In the context of cryptocurrency derivatives, options trading, and financial engineering, an Insurance Fund represents a dedicated pool of assets designed to mitigate systemic risk within a specific protocol or trading environment.
Maintenance Margin
Collateral ⎊ Within cryptocurrency derivatives and options trading, the maintenance margin represents the minimum equity a trader must maintain in their account to cover potential losses.
Margin Cushion
Buffer ⎊ A margin cushion, within cryptocurrency derivatives and options trading, represents the percentage of equity held above the initial margin requirement, functioning as a critical risk mitigation tool.
Liquidation Risk
Risk ⎊ Liquidation Risk is the imminent threat that a leveraged derivatives position will be forcibly closed by the exchange or protocol due to insufficient margin to cover adverse price movements.