Executing the Trade

The "cash and carry" trade is a classic arbitrage strategy used in the futures markets, particularly effective during periods of market backwardation. This trade involves buying an asset in the spot market and simultaneously selling a futures contract on the same asset when the futures price is below the expected future spot price. The idea is to profit from the difference between the current spot price and the lower futures price.

In practice, an investor or trader buys the underlying asset (such as Bitcoin) and holds it, while selling a futures contract to promise delivery of the asset at the contract's expiration date. By doing so, the trader locks in the price difference as a guaranteed profit, assuming no changes in the cost of holding the asset. This strategy is deemed "risk-free" under perfect market conditions, as it exploits the pricing inefficiencies between the spot and futures markets.

The cash and carry trade is especially appealing in a backwardation market where the futures price is set to increase towards the spot price. It allows traders to capitalize on the positive carry from the trade (the cost savings from buying at a lower futures price) while hedging against price movements in the spot market by holding the physical asset.

Let's use an example to illustrate how the trade happens:

1. The current hypothetical BTCUSD perpetual funding rate is 0.02% (we are using this value to run simple calculations, while 0.02% is close to recent market averages)

   • As the funding rate is positive, the market is in backwardation, and the cash and carry trade is possible

2. The investor buys 1 BTC at the current spot price, and opens a corresponding short perpetual, achieving a delta-neutral position. This means the investor's net position isn't affected by Bitcoin price movements

   • The key for the investor is to monitor the funding rate. As long as it remains positive, the investor receives payments for keeping the short position open

3. Assuming a simplistic scenario where the funding rate stays the same over 30 days, the investors lock in a 1.8% 30-day return. Calculations below. (Note, in practice, the funding rate fluctuates.)

   • 0.02% * 3 = 0.06% (daily return - the funding rate is expressed for a 8 eight hours period)

   • 0.06% * 30 = 1.8% (30-day return)