Solana futures are so mispriced, arbitrageurs are earning 23% yields

Futures contracts for Solana (SOL) are so mispriced that arbitrageurs are earning annualized interest rates of 23% on exchanges with institutional credibility and millions of dollars worth of available liquidity. 

Yesterday, monthly CME futures contracts for SOL expiring in October were trading at a 2.8% premium to spot. That created a substantial yield for a two-legged trade that could have conservatively achieved a USD denominated annualized yield of 23%.

The specific type of mispricing is contango — an anomaly when the futures price of an asset is higher than the expected spot price at contract expiration.

To illustrate this, consider the simultaneous prices of SOL futures and spot SOL on the CME in October that one arbitrageur captured yesterday: $237.60 and $230.97, respectively.

If an arbitrageur was indifferent to the price of SOL and simply wanted to lock in a market-neutral, USD-denominated yield, they could have shorted October futures contracts and bought spot to offset their entire position.

Capturing the above contango would earn 2.8% after 1.5 months. Unless the CME failed to settle these futures contracts — and it hasn’t failed to settle any futures contract since 1976 — there are few institutional risks to selling short these futures contracts.

Other risks to arbitraging Solana futures

Of course, prior to October 31, the price of the futures contracts could continue to rise. Although the contract is guaranteed to expire at parity with spot, contango can persist and even grow during the days prior to expiry.

Although the CME contractually prices its futures and always settles them correctly on the expiration date, the free market prices them on a day to day basis.

Therefore, any investor with a short whose position moves against them is responsible for posting additional margin according to their broker’s demands.

The above arbitrageur used 40% margin as a realistic illustration, or $40,000 to open a $100,000 notional position.

If the price of SOL or its futures rallied 10%, that $100,000 notional position might turn into a $110,000 position, triggering a $4,000 margin call to the arbitrageur.

In any case, at the October 31 expiration, the futures contract will return the 2.8% or $2,800 on the $100,000 notional position to the arbitrageur.

Of course, to be conservative, the above arbitrageur assumed it would take a prospective trader a couple weeks to post collateral and time entries and exits, so they only considered a single month of holding time, rather than one and a half months, and also conservatively reduced the contango from 2.8% to 2.5%. 

Annualizing 2.5% monthly returns on $100,000 in notional futures with 40% margin requirement re-calculates to $30,000 worth of return annually.

On the other leg of the trade, an arbitrageur would simply buy and stake spot SOL. Assuming an equal, $100,000 spot position to offset the $100,000 notional short futures position, that staked position would earn about $6,300 after 12 months of staking rewards.

Read more: Solana receives backlash for Ethereum-NASDAQ comparison

23% return using Solana and futures, with big caveats

Putting it all together, an arbitrageur would have earned $30,000 plus $6,300 on a $140,000 position. This assumes a 2.5% monthly contango recurred on every monthly CME futures contract of the year and also that the contango didn’t materially worsen above 2.5% to require much more than $40,000 in brokerage margin to maintain the short position.

Both of these are considerable assumptions.

Nonetheless, a $36,300 return on $140,000 is a 25.9% annual return. After fees and commissions, that could clear 23% annually in USD, as the arbitrageur noted.

As of publication time, the contango on CME SOL October futures has reduced to 0.4% and fluctuated as high as 1.8% during the writing process. That reduction from 2.8% is good news for an arbitrageur who sold short yesterday, but it’s bad news for someone looking to enter the trade today.

These fluctuations are normal in actively traded markets.

For arbitrageurs looking to maximize their yields and achieve above-average returns on an annual basis, patient bids for mispricings between correlated markets is part of the job.

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