Arbitrage & Hedging Guide: Basis, Funding and Hedge Ratio

Arbitrage and hedging are two different jobs

Arbitrage tries to capture temporary mispricing between two related prices (for example futures trading above spot) while hedging away directional risk. Hedging instead protects an existing exposure from adverse moves without chasing extra profit.

Both share one question: does your exposure size match? That is where hedge ratios and position math come in.

Basis and spot-futures arbitrage

Basis = futures price − spot price. Positive basis (futures above spot) is common in bullish sentiment; basis tends to converge near delivery. A classic carry trade buys spot and shorts futures when positive basis is wide, then closes as basis converges.

It is not risk-free: capital is locked on both sides, rolling has costs, the futures leg can be liquidated in extreme moves, and basis can widen before it converges.

Feed futures price, spot price and time to delivery into the basis calculator to read the current basis and its annualized equivalent, so you can judge whether the spread is worth the capital.

Funding-rate arbitrage: collecting perp carry

When perpetual funding is persistently positive, longs periodically pay shorts. Funding-rate arbitrage keeps a delta-neutral book (hold spot, short the perp) to collect that funding income.

The realized annualized return is not just the single rate scaled up: fees, funding flipping negative, basis/forex drift and venue risk all matter. Use the funding-rate arbitrage estimator with rate, interval and fees for a conservative number.

Hedge ratio: how much futures to sell

The simplest hedge is spot notional ÷ notional per futures contract. If your portfolio's correlation with BTC is not 1, multiply by a beta to refine the ratio.

A full hedge removes most directional upside and trades it for smoothness; a partial hedge keeps some view while capping drawdowns.

Real constraints on arbitrage and hedging

• Capital efficiency: both legs tie up funds, so annualized returns on capital used are often modest.
• Capacity and slippage: large entries move the spread themselves and eat theoretical profit.
• Liquidation risk: a hedged short can still be liquidated in an extreme rally unless margin is reserved.
• Venue risk: holding spot on one exchange and futures on another adds counterparty risk.

Run the numbers first

• Use the basis calculator to check the basis direction and its theoretical annualized return before starting a carry.
• Use the funding-rate arbitrage estimator to get net annualized figures for funding strategies — deduct fees.
• Use the hedging ratio calculator (including beta) to decide how many futures contracts your spot portfolio needs.
• Use the funding rate calculator to model long-term funding costs and confirm the net result stays positive.

This guide is for educational purposes only and is not investment advice. Always follow your exchange's actual margin, liquidation and fee rules, and keep a buffer for extreme market moves.

If you want to cut down on manual work, the same flow can be executed automatically under the same rules by a quant system such as CubeQuants.