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Buy X amount of an asset in the spot market. For example, we buy 1 SOL/USD at $100 for 100 USD.
Short the same amount X of the same asset in the futures market.
For example, we sell 1 SOL-0625 June at $120, which expires in 90 days and is trading at a 20% premium. Our spot holdings will function as collateral for this short.
At expiry, our spot holdings and realized PNL on the short will be worth $100 plus an additional 20% that we achieved through the premium, so $120. We sell the remaining 1 SOL/USD and will be left with 120 USD.
If SOL/USD goes down, we will realise a loss on our spot holdings, but a profit on our SOL-0625 futures short position.
If SOL/USD goes up, SOL-0625 will also go up and we will realise a loss on our futures short position, but a profit on our SOL/USD holdings.
This means that we have a delta neutral position. Price movements of the asset will not influence our position.
At expiry, the price of our futures will always converge to the price of the underlying spot asset.
Because of this, we are taking advantage of the premium by being able to short at a higher price. Once the prices converge, we will pocket the difference.
For example, imagine the spot price of SOL/USD is at $80 at expiry, which was in 90 days. Due to the way that futures work, the price of the futures will also be the same.
This means that we made a loss of $20 on our spot holdings ($80-$100), however, we made a $40 profit on our futures short ($120-$80).
We made a total profit of $20 on our initial purchase of $100, a 20% return in 90 days.
Another example, imagine the spot price of SOL/USD is at $140 at expiry.
This means that we made a profit of $40 on our spot holdings ($140-$100), however, we made a $20 loss on our futures short ($120-$140).
We once again made a total profit of $20 on our initial purchase of $100, a 20% return.
Buy X amount of an asset in the spot market. For example, we buy 1 SOL/USD at $100 for 100 USD.
Short the same amount X of the same asset in the futures market.
For example, we sell 1 SOL-0625 June at $120, which expires in 90 days and is trading at a 20% premium. Our spot holdings will function as collateral for this short.
At expiry, our spot holdings and realized PNL on the short will be worth $100 plus an additional 20% that we achieved through the premium, so $120. We sell the remaining 1 SOL/USD and will be left with 120 USD.
If SOL/USD goes down, we will realise a loss on our spot holdings, but a profit on our SOL-0625 futures short position.
If SOL/USD goes up, SOL-0625 will also go up and we will realise a loss on our futures short position, but a profit on our SOL/USD holdings.
This means that we have a delta neutral position. Price movements of the asset will not influence our position.
At expiry, the price of our futures will always converge to the price of the underlying spot asset.
Because of this, we are taking advantage of the premium by being able to short at a higher price. Once the prices converge, we will pocket the difference.
For example, imagine the spot price of SOL/USD is at $80 at expiry, which was in 90 days. Due to the way that futures work, the price of the futures will also be the same.
This means that we made a loss of $20 on our spot holdings ($80-$100), however, we made a $40 profit on our futures short ($120-$80).
We made a total profit of $20 on our initial purchase of $100, a 20% return in 90 days.
Another example, imagine the spot price of SOL/USD is at $140 at expiry.
This means that we made a profit of $40 on our spot holdings ($140-$100), however, we made a $20 loss on our futures short ($120-$140).
We once again made a total profit of $20 on our initial purchase of $100, a 20% return.