📈 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)
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
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