In the ever-evolving world of cryptocurrency trading, savvy traders are constantly on the lookout for effective strategies to manage risk and enhance returns. One such strategy is the delta neutral approach, which aims to reduce the impact of market volatility on a trading portfolio. In this article, we will delve into the concept of delta neutral strategy, its applications in crypto trading, and provide examples to illustrate its effectiveness.
Understanding Delta Neutral Strategy
The delta neutral strategy is a risk management technique commonly employed in options and futures trading. It involves creating a portfolio with a net delta value of zero, meaning that the portfolio’s overall value remains unaffected by changes in the underlying asset’s price. This is achieved by combining long and short positions in such a way that the portfolio’s sensitivity to price changes is minimized.
In the context of crypto trading, a delta neutral strategy can be employed to hedge against market volatility and protect the value of a portfolio. By carefully selecting and combining long and short positions in various cryptocurrencies or derivatives, traders can create a portfolio that remains relatively stable in the face of price fluctuations.
Benefits in Crypto Trading
- Hedging against market volatility
Cryptocurrency markets are notoriously volatile, with prices often experiencing significant fluctuations within short periods. By adopting a delta neutral strategy, traders can protect their portfolios from the impact of such price movements and reduce the risk of substantial losses.
- Enhancing returns
A delta neutral strategy allows traders to take advantage of arbitrage opportunities arising from price discrepancies between different cryptocurrencies or derivatives. By simultaneously buying and selling these instruments, traders can lock in profits without being exposed to the risk of price fluctuations.
- Flexibility
The delta neutral approach offers traders the flexibility to adjust their positions as market conditions change. By continuously monitoring the portfolio’s delta value, traders can make adjustments to maintain a delta neutral position and minimize the impact of price movements on their portfolio.
Examples in Crypto Trading
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Crypto options and futures
In this example, a trader holds a long position in Bitcoin and wants to hedge against potential price declines. To achieve a delta neutral position, the trader can buy put options or sell futures contracts with a delta value that offsets the long position in Bitcoin. This way, any losses incurred due to a decline in Bitcoin’s price would be offset by gains from the put options or futures contracts.
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Pairs trading
Pairs trading involves taking long and short positions in two cryptocurrencies with a high degree of correlation. For instance, a trader might go long on Bitcoin and short on Ethereum, expecting that the price of Bitcoin will outperform Ethereum. By carefully selecting the position sizes, the trader can create a delta neutral portfolio that remains stable regardless of the overall market movements.
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Derivatives and stablecoins
In this strategy, a trader holds a long position in a cryptocurrency derivative, such as a futures contract or a perpetual swap, while simultaneously holding an equivalent amount of stablecoins. The stablecoins act as a hedge against price fluctuations in the derivative, ensuring that the portfolio’s value remains relatively stable.
4. Funding rate arbitrage
In this strategy, a trader will take a long position on one exchange and a short position on another to collect the funding fees. They will also buy spot and stake it and collect interest and then short the perp. You can also Borrow spot which essentially makes you short that coin and then buy perps. There are many different options so it’s a matter of searching and finding what’s out there. One that I was in for some time last year was $LOOKS. I bought spot and staked on their website which was paying around 360% and shorted the perp on an exchange. Because a lot of others were doing the same the rate to short was also high around 200%. So I was collecting 160% and not stressed about price movement.
Finding Funding Rate Arbitrages
You can find the updated funding rates on Coinglass which I’ll be using for this example.
On the front page you’ll find the menu Funding. If you click there it will take you to a list of the updated funding rate of several exchanges.
You can use the tool they have available which can help you find some options by clicking the Funding rate arbitrage calculator. It will calculate what you would make on funding depending on the size of position you take. Or you can find the opportunity yourself by clicking the exchange which will organize the coins in order of highest to lowest funding on that exchange. Click again and it will reverse the order.
In this example we see 3 possible opportunities that we found.
- UMA– Long on OKX and collect .0279% funding and Short on DYDX and collect .1794% funding.
- CRV– Long on OKX and collect .0007% funding and Short on DYDX and collect .0312% funding.
- YFI– Long on OKX and collect .0020% funding and Short on DYDX and collect .0236% finding.
Some things to keep in mind our that funding changes regularly so it’s important to monitor the funding. It’s also important to keep in mind your entry and exit while getting into a position. Remember the reason they are paying funding is because they want the price to trade in line with spot so as price corrects and gets in line with the spot you could be down more on one position than another.
Takeaway
The delta neutral strategy is a powerful risk management tool that can help crypto traders navigate the unpredictable world of cryptocurrency markets. By carefully selecting and combining long and short positions, traders can create a portfolio that remains relatively stable in the face of price fluctuations, thereby reducing the risk of losses and enhancing returns. While the delta neutral approach may require a higher level of market knowledge and expertise, it can be a valuable addition to any crypto trader’s toolbox.