Non-Deliverable Forward

Understanding Non-Deliverable Forward in Cryptocurrency Option Trading

A Non-Deliverable Forward, often shortened to NDF, is an essential term within the sphere of option trading with cryptocurrencies. NDF is a futures contract where the parties don't exchange the underlying asset. Instead, they settle the difference in the exchange rates of an asset, like cryptocurrencies, in cash.

How does a Non-Deliverable Forward work?

A Non-Deliverable Forward functions by allowing two parties to speculate on the price movement of a given cryptocurrency. Rather than transferring the digital asset itself, these parties agree to exchange the monetary difference between the NDF contract price and the prevailing market price at an agreed date in the future. This is calculated using a notional amount, which isn't exchanged, but it's used to calculate the cash settlement.

Application of Non-Deliverable Forward

NDFs are particularly popular in markets where direct trading of cryptocurrencies is restricted or not possible. This financial instrument provides a workaround to those restrictions, allowing investors to speculate on the future value of the cryptocurrency without having to own it. This becomes particularly handy for investors in countries where direct trading of cryptocurrencies is banned.

Non-Deliverable Forward vs Deliverable Forward

The key difference between a Non-Deliverable Forward and a traditional deliverable forward is the lack of physical delivery of the underlying asset in the former. With a deliverable forward contract, the holder is obligated to buy or sell the underlying physical asset at the contract's expiry. However, in an NDF, the parties simply settle the price difference in cash.

Benefits and Risks of using Non-Deliverable Forward

NDFs offer several benefits such as providing access to restricted markets, flexibility, and potential risk management. However, they also have their fair share of risks like price volatility, counterparty risk, and potentially unlimited losses. Despite these risks, with careful planning and execution, NDFs can prove to be a useful tool for speculating on cryptocurrencies.