How to hedge crypto
Stop loss is essential, but can they save you from heavy losses? As mentioned above, cryptocurrencies are fundamentally volatile assets, and even if the price action is going as planned, there could be stop hunting. Stop hunting is a strategy that tries to force some market participants out of their positions by pushing the price of an asset to a level where many have chosen to set stop-loss orders.
Bitcoin dominance Altcoins follow Bitcoin's price actions, i. But if a coin is nearing a breakout or has broken out due to some recent developments and Bitcoin dumps, that breakout would abruptly turn into a fakeout. Top crypto hedging strategies As a trader, below are the four most popular strategies that can be used for crypto hedging against the market to secure your holdings.
Short selling In short selling, traders take a position to short an asset when they believe that their spot holding will temporarily or for an indefinite amount of time fall in value. With short selling, traders can also sell their spot holdings and buy back when the price is lower, securing the gains and thus securing more buying power. In other words, short selling allows investors to hedge against the downside risk of a long position in the same cryptocurrency or a related one.
Basically, short selling in cryptocurrencies protects against long exposure. However, shorting might bring complexity to margin trading since increased borrowing power could raise your liquidation price. Futures Future is essentially a contract between two or more parties that agrees to buy or sell an asset in the future at a pre-determined and agreed-upon time.
In secondary markets, the futures contract can be sold before the agreed-upon date. Futures contracts are part of many trading instruments known as derivatives, including Contracts for Difference CFDs , Options, and Swaps. Investors can open a short position when they think a pullback is due; in secondary markets, they can open a short position, earn some capital and invest when the price is lower.
Cryptocurrency futures allow users to leave their position open, maximizing their profits from your crypto investments. Futures contracts can be a good hedge for investments or lock your profits in a volatile market such as cryptocurrency. These are ideal for investors who want to hedge their exposure in the crypto market for a reasonable period. In perpetual swaps, investors can exit at any time they want.
With perpetual swaps, investors can get more buying power than they have; hence it is easier to take advantage of the price fluctuations while holding your position in the spot. Additionally, perpetual swaps operate on a funding rate mechanism that rebates to continue holding the position. The fee is deducted from the margin provided by the investor. This strategy has gained traction in the crypto market since it enables traders to leverage positions without an expiration date.
Perpetual swaps have proven to be a great aid to retailers who want to increase their buying power. The perpetual swap also incentivizes traders to long the asset when the index price is bearish. The funding rates are usually designed to ensure price stability. Based upon your holdings and what is available on the exchange, you need to calculate which combination of futures contracts you need as well as how many contracts; similar to what I did in the calculation section in the example above.
Close out your short position whenever you wish to close out your hedge. Summary Hedging with futures is best suited for crypto investors that carry the standard coins and want to hedge their exposures an efficient way. A good understanding is highly recommended to fully assess the risk of using financial derivatives.
Pros and Cons for using futures for hedging: Risks Please refer to this for some basic information on the mechanics of futures. It is recommended to research more on futures if that is what you intend to use and read the fine print in each of the futures contracts you use. Just like short selling there are risks to using futures including exchange default risk.
Below is the more common ones I can think of besides those mentioned in short selling: Deviation In Price Of Underlying Futures contract all state the method in which it is priced upon and there could be instances where it deviates from the general market price of the crypto just like I explained in short selling. It is the idea that future prices do not move in-line with the spot prices. To make matters worse you also have to asses the default risk of the futures crypto exchange and anything that happens to the particular exchange you are using.
Other Factors Some futures exchanges have special clauses to protect themselves but can harm your investments hence it is important to read the fine print of your futures contract. One popular one is known as societal loss which I will cover in a separate article.
Their use is very similar to that of inverse futures with the main differences being: A periodic funding rate usually 8 hours No expiration date To understand the perpetuals you can check this link here which is the guide by Bitmex, the first crypto exchange to have perpetuals.
Some of the concept such as calculating the funding rate can get complicated however to use swaps only a high level understanding is needed as the systems will calculate funding rate for you. Why You Would Use This The key reasons to use this are the same as futures with the main difference being that the short funding rate means that the perpetual swaps track the underlying prices closer than the future for most cases.
However this also means that your actual hedging cost can vary since funding rates are re-adjusted every 8 hours. Also not having to deal with rollovers means you incur less trading costs. How You Construct This The portfolio construction is the same as inverse futures so you can refer to the previous instructions except you would need an account with crypto futures exchange that offers perpetual futures.
Summary Just like futures, hedging with swaps is best suited for crypto investors that carry the standard coins and want to hedge their exposures in an efficient way. Pros and Cons are the same for futures and swaps so instead I have compared it to using futures instead for the table below: Risks As this is the same as futures I will not elaborate on it in the previous section. The only exchanges that offer it are currently Deribit and Bitmex.
However they have been around in the financial markets for ages and often used for hedging purposes. Here is a link of the basic mechanism of options for your reference. Hedging with options can be pretty complicated and there are multiple ways you can build the payoff you want. However below is one of the most straightforward ways to hedge out your downside risk that I know of. It is not the cheapest hedging method, as there could be a version of it where you sell call options etc.
It also gets you started on using options for hedging. All cryptocurrency references below are used only as an example. Why You Would Use This One of the main benefits to using options in this way to hedge out risk is the difference in payout. Buying put options to hedge can effectively turn your existing options into a call option payout limited downside with unlimited upside.
In addition margin does not need to be monitored because we are purchasing options to construct this hedge. Thus this makes it a fairly good choice for investors that are: Looking to hedge but cannot or do not want to have to deal with monitoring their margin requirements Want downside protection but maintaining the potential upside gains and do not mind paying more for this.
For your chosen ITM put option price check its current price and calculate how much funds you would need to have to deposit to own enough for coverage of your BTC holdings. Deposit the funds into the exchange probably best to deposit a bit more as buffer in case prices move.
Purchase the put option and hold it until expiration you could liquidate it in the middle if you wish to but the hedging cost could be more costly depending on the market conditions and liquidity Summary As mentioned hedging with options can be quite complex but also means it can be better tailored for your needs. Hence it could be worth understanding more if you hedge frequently. Instead I have covered the basics here to get you started and provide a fairly different style of hedging.
Pros and Cons relating to the options hedging method described above: Risks Same as futures hence I will not elaborate on it. You can click here to read the previous section. Final Thoughts Hopefully this has got you thinking about hedging in a different perspective and provided some idea to get you started. Of course questions are welcome as well. Extra: Why Do People Hedge? But in some cases they might not want to because they are: A Miner Miners need to pay their electricity and other costs in USD so they may wish to have more predictability on their returns.
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It involves placing a short-sell order at key trend turning points, resistance levels, or following a confirmed breakdown from a chart pattern support. In a short position, a trader borrows a coin and sells it when the position is opened. When the trader closes the position, they buy back the coin and profit from the difference.
The act of covering forced short traders to close rapidly in succession, creating a significant number of buy orders. Combined with natural buying of a breakout short squeeze can be especially powerful movements. Crypto traders would use shorting as a hedging strategy to counter a spot position in the same cryptocurrency. Using an example of how to hedge Bitcoin, someone who holds BTC for the long-term might want to consider hedging spot positions with a short at resistance levels.
This hedging strategy works for any type of cryptocurrency. Staking Crypto Shorting cryptocurrencies does take some skill and requires supporting technical analysis. However, staking among the fastest growing crypto hedging strategies today due to the relative ease related to it. Staking involves locking up idle crypto assets in exchange for a variable interest rate called an annual percentage yield APY. Consider a situation where the market moves sideways for an extended period.
Profits are more challenging to come by at this time due to the lack of market direction. With staking, the crypto you hold can still make you more money. If you are holding crypto anyway, when the market is climbing your returns will compound due to most staking setups offering daily payouts in the cryptocurrency being staked.
If the market is declining, your staking assets will earn an APY while everyone else is losing money. Staking has become more popular over the last several years. Margex has also introduced an innovative trade while staking feature where users can utilize their staked crypto assets as account collateral for margin trading, enabling the ability to trade staked.
Portfolio Diversification Portfolio diversification is the most complex of our cryptocurrency hedging strategies, because there are simply so many ways to approach it. For example, buying NFTs could be considered portfolio diversification. If you believe that Dogecoin is a better payment currency than Bitcoin, consider hedging Bitcoin with a position in Doge. If Ethereum continues to struggle with the total number of TPS it can process, a position in Solana could perform well. There are seemingly endless ways to diversify a crypto portfolio with other digital assets.
However, because the crypto asset class is highly correlated, portfolio diversification more commonly involves hedging crypto with traditional assets or cash. Moving into stablecoins that are pegged to the price of fiat currencies is also a wise hedging strategy during market downturns.
Assets with low correlation to crypto include currencies, commodities, and precious metals like gold and silver. Investors can use technical analysis software with scatterplots to compare two assets and get a better understanding of what type of correlation exists.
Derivatives Trading Derivatives trading involves trading different types of contracts that utilize the price of a particular asset. Derivatives traders use a variety of methods to attempt to profit from normal price fluctuations. These more advanced methods of hedging crypto with derivatives include perpetual swaps, options, and futures.
Different Types of Derivatives Hedging Strategies: The Ultimate Crypto Hedging Strategy Explained Trading derivatives like options, futures, and perpetual swaps is the ultimate crypto hedging strategy. Here is everything you need to know about each type. Options An options contract gives the holder the right, but not the obligation, to buy or sell an underlying at a specific strike price on or before a certain date.
In options, there are four basic ways to take a position: buying a call option, selling a call option, buying a put option, and selling a put option. When taking an options position traders can buy or sell to open and buy or sell to close. Buyers and sellers make a profit depending on the type of the option: put or call.
Using call options, buyers expect the market price of an underlying asset to increase beyond the strike price. Using put options, buyers are expecting the market price of an underlying asset will decline below the strike price, while the seller is betting it won't. In options, the strike price is a fixed price at which the options trader can buy, or sell, the underlying asset or cryptocurrency.
If the spot index price is the same as the options strike price, then there is zero intrinsic value of the contract. If an options trader is incorrect, since there is no obligation to exercise the contract, there is no substantial loss associated with the trade.
In exchange for the lack of risk on the backside of the trade, options traders pay a premium to open the options contracts. Options sellers who offer options to collect a premium are also referred to as options writers while buyers of options are called options holders.
Options writers are also sometimes called grantors. The Greeks are: vega, delta, gamma, theta, and rho. Theta is a measure of time decay and its impact on an option the closer it gets to its expiration date. Rho measures how much the price of an option should rise or fall per one percentage point change in the interest rate. Not only are options a way to spot hedge crypto or speculate, large firms who derive their revenue from cryptocurrencies like Bitcoin can use options as an insurance policy.
For example, Bitcoin miners regularly hold BTC. Their entire business model depends on Bitcoin and business revenue performs best when Bitcoin is in a bull market. Such a business can buy a put option to generate ROI from the trade that offsets any decline in revenue. Futures By definition, futures are a financial contract to buy or sell in the future between two parties.
Futures are derivative financial contracts which obligate the buyer to purchase an asset or the seller to sell an asset at a predetermined future date and set price. Futures typically rely on a price index of the underlying asset. Bitcoin futures and Ethereum futures have become incredibly popular as the asset class gains wider acceptance.
Futures allow investors and traders to gain exposure to these crypto assets without owning the underlying asset. Futures let traders also speculate on the future price of any cryptocurrency, hence the name. Futures can be settled in cash or in the underlying asset itself. Futures also allow investors to hedge spot positions of the same asset. Instead, they can hedge these spot positions with a short futures position. Futures offer a number of tax benefits, in fact.
Futures are typically listed by their expiration month. Unlike options which include time decay and eventually become worthless, futures must be settled by the buyer and seller. Perpetual Swaps Unlike options and futures trading, perpetual swaps never expire. Since the contracts never settle, derivatives trading platforms utilize a funding rate to ensure the contract price and spot price stay relatively similar and converge regularly.
When the contract price is trading at a rate higher than spot price, the contract is trading at a premium and longs must pay shorts a funding rate. When the contract price is trading at a rate lower than spot price, the contract is trading at a discount and shorts must pay longs a funding rate. Since the funding rate is essentially a periodic rate paid to traders for holding positions, a high funding rate could encourage more traders to go long or short, which reduces the premium or discount.
Funding rate can also put pressure on one side of the market to close and can impact trends at decisive moments. In more simple terms, the funding rate helps keep the market in balance. Perpetual swaps let traders hedge spot crypto holdings or speculate over cryptocurrency price action. The Margex margin trading platform offers perpetual swaps on Bitcoin, Ethereum, Ripple, Litecoin, and other popular cryptocurrencies.
The next section will walk you through how to use the platform to hedge crypto using perpetual swaps short positions. Follow these four simple steps with supporting examples. Reversals commonly appear at key resistance levels and are an ideal place for a market entry.
Step 2 - Look for supporting bearish signals such as doji patterns or bearish divergences. At this point, place a short-sell order to hedge your crypto holdings using perpetual swaps. It is also very hard to transport and store. Even real estate has been hurt, especially since the market crash of People had to look for other assets that could protect them from inflation because traditional options were no longer as good as they used to be. Indeed Hedging crypto works very well.
So, Enter Bitcoin! How does bitcoin serve as a hedge against inflation? Bitcoin is a good way to protect yourself from inflation because there are only so many coins. Since then, about 19 million coins have been made, so only 2 million more need to be made. By doing so, a new blockchain would be made. Also, Bitcoin is much easier to move around than gold. It can be sent in a matter of seconds from one part of the world to another. It is also available to anyone with a smartphone and internet access.
Since it came out, the price of Bitcoin has also changed a lot. When it was first created in , it was worth less than 1 cent per unit. It should be a great way to protect against inflation, in theory. It is hard to get, so it is a scarce asset. It is fungible, meaning you can trade one bitcoin for another without decreasing the value.
It is also easy to get to, widely accepted, and appreciated. But because of many different things, its price has been very unstable.
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How to Hedge Crypto - Profit from any direction!NETS CLIPPERS
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