How Does the Liquidation Risk in the Futures Leg of a Basis Trade Impact the Strategy?
Liquidation risk is the primary threat to a leveraged basis trade. If the market moves against the short futures position (e.g. a sharp price rise in a long spot/short futures trade), the futures account could be liquidated.
This breaks the market-neutral hedge, leaving the trader with an unhedged long spot position and a realized loss on the futures. The strategy's success relies on maintaining both legs until convergence.
Glossar
Liquidation Risk
Exposure ⎊ Liquidation risk, within cryptocurrency derivatives and options trading, represents the potential for forced asset sales due to margin calls triggered by adverse price movements.
Futures Leg
Derivation ⎊ A futures leg, within cryptocurrency derivatives, represents a component of a more complex trading strategy, often involving options or other futures contracts; its value is intrinsically linked to the underlying asset’s anticipated price movement, serving as a building block for structured payoffs.
Basis Trade
Mechanism ⎊ A Basis Trade, within cryptocurrency derivatives, represents a strategy exploiting discrepancies between spot and futures contract prices, aiming for risk-neutral profit.
Short Futures Position
Exposure ⎊ A short futures position in cryptocurrency derivatives represents the obligation to deliver an underlying asset at a predetermined price on a specified future date, inherently establishing a negative exposure to anticipated price increases.
Margin Requirements
Collateral ⎊ Margin requirements represent the equity a trader must deposit with a broker or exchange as a good faith measure, securing potential losses arising from leveraged positions within cryptocurrency, options, and derivative markets.