📈 PnL mechanics: How to profit with Rho

For a given Rho market:

• The floating rate is the external rate which this market references. For example, the floating rate of a Binance BTCUSDT Perp Funding Rate market will trace the 8-hour funding rate (e.g., 0.0095%) for BTCUSDT perpetual future currently observed on Binance.

• The Rho rate (fixed) is the last fixed rate observed on a given Rho market.

To better understand the Rho markets and PnL mechanics, it is essential to appreciate the connection between a market’s Rho FUnding Rate and the reference floating rate the market is tracing.

Rho rate (fixed)

The Rho rate of a given instrument implies the market’s expectation of an average floating rate between the current point in time and the contract’s expiry.

Contract: Binance BTCUSDT Funding Current date: June 14th, 2024 Expiry: JUN-24 (expires on June 28th, 2024) Current floating rate: 11% p.a. (equivalent 0.0095% per 8 hours) Rho rate: 15.0% p.a. (fixed)

The current Rho rate shows that the market expects the future rate to be higher than today’s 11%.

Example:

Crypto trader John, familiar with the perpetual futures market, observes Rho's Binance BTCUSDT Funding for the BTCUSDT pair trading at 15%.

John trades on Rho as a Receiver and 'sells' futures of USDT 1M notional at a 15% fixed rate over 3 months. The funding rate averages 11% during the contract term, allowing John to profit from the 4% difference, earning USDT 10,000

John's profit = USDT1,000,000 Notional * (15% fixed rate - 11% floating rate) * 3 months / 12 months a year = USDT10,000

Six months later, trader Amy sees the same Funding Rate Futures negotiated at 5%.

She decides to 'buy' future contracts of USDT 5M notional at a 5% fixed rate over 2 months, making her a Payer.

Due to significant market changes, the funding rate averages 20%, allowing Amy to earn the 15% difference over the fixed rate, calculated over 2 months, resulting in a profit of USDT 125,000.

Amy's profit = USDT 5,000,000 Notional * ( 20% floating rate-5% fixed rate) * 2 months / 12 months a year = USDT 125,000