Compilation of the original text: The Way of DeFi
Original source:Bankless
Compilation of the original text: The Way of DeFi
Seasoned investors love options because they can be applied to any investment theory.
They are often used to hedge against volatility or to speculate with leveraged exposure.
But one of the golden use cases is how to make profits in a stagnant "crab" market with a Delta Neutral (note, risk-neutral, neither partial nor risk-averse) strategy.
In TradFi, this is almost only possible for the most experienced traders, as they deeply understand the strategies and are able to actively manage their positions.
But DeFi changed that.
We can program these complex policies into smart contracts and fully automate them, giving anyone one-click access to the policies. For the end user, it is just a passive income.
How to deploy these strategies to your advantage?
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Image credit: Logan Craig
TL;DR
Crypto-native automated strategies for any market conditions, including when ETH is trading sideways.
The term "Delta neutral" generally describes strategies involving long and short positions, where the combined exposure of the positions is market neutral (best for crab markets 🦀, aka sideways markets).
In short, a Delta neutral trade is to take a position that will not react to small changes in the price of the underlying asset.
In DeFi, delta-neutral strategies can be packaged into structured products, enabling users to obtain dollar-denominated returns in sideways markets with one click.
Many traders know how to make money during bull or bear markets, but what about sideways markets that don't fluctuate much?
One of the benefits of DeFi’s open, programmable “Money Legos” ecosystem is that crypto-native structured products work in any market condition, including ETH sideways.
Financial jargon aside, DeFi has enabled automated strategies that allow any trader to earn returns with just one click, even as ETH prices remain flat. Users make deposits in the vault and the contract handles the rest. DeFi traders now have the ability to participate in relatively more complex financial strategies without having to manually trade them themselves, which is common in traditional finance.
In traditional finance, portfolio strategies designed to make money in sideways markets are known as delta neutral strategies. A Delta neutral trade is to take a position that will not react to small changes in the price of the underlying asset.
This article first explains Delta neutral trading, then shows two different automated Delta neutral strategies using options, and finally presents manual examples and examples of other Delta neutral/market neutral DeFi strategies.
What is a Delta transaction?
Delta measures a position's directional exposure, the change in option price for each $1 increase in the underlying price.
Delta values range from -1 to +1, where 0 indicates little change in the value relative to changes in the price of the underlying asset.
Example: Holding ETH has a Delta value of 1 because for every $1 ETH price goes up, it will gain $1. Conversely, it loses $1 for every $1 that the ETH price drops.
Remember, Delta means "change" or "change" in value.
Positive Delta: For a position with a Delta value of 0.5 on ETH, you can earn $0.5 for every $1 increase in the price of ETH. Also, for every $1 that the ETH price drops, the position will lose $0.5.
Negative Delta: A position with a Delta value of -0.5 on ETH will earn $0.5 when the price of ETH falls by $1. Conversely, if the ETH price rises by $1, the position will lose $0.5.
The higher the Delta value of a position, the more bullish it is. And vice versa, a lower Delta value is more bearish. A position with a Delta value of approximately 0 is said to be market neutral, with no apparent directional risk.
Delta Neutral: "Delta Neutral" generally describes a strategy involving long and short positions, where the combined delta of the positions is zero or close to zero, with no apparent directional risk.
The term can refer to many different strategies, but the concept of delta neutrality (Delta around 0) is always a central theme. Delta neutral positions balance responses to market movements within a range (up or down) such that the net change in position is equal to or close to zero.
For example, if a position has a Delta value of 0.03, when the underlying asset increases by $1, its value will only change by 3 cents.
For the purpose of this article, we will discuss delta neutrality using options.
Strategy 1: Opyn Crab v2
Opyn is the first team to launch an options protocol on Ethereum in early 2020. In January 2022, Opyn and Paradigm announced theSqueeth, the first Power Perpetual in existence, designed to give traders permanent exposure to ETH².
Squeeth is a DeFi-native derivative that makes options permanent (no strikes, no expirations).
Long Squeeth is a leveraged position with unlimited ETH² upside and protected downside with no liquidations. A Short Squeeth is a short ETH² position that allows traders to receive a return (funding rate) paid by long Squeeth holders.
CrabA strategy is an automated strategy that allows users to earn money (yield) by shorting Squeeth.
Since its inception, Crab is up 7.73% in USD and 35.66% in ETH.
During the same period, ETH lost 20.59%.
high level overview
Crab v2 is an automated strategy that earns USD-denominated returns for users in sideways markets.
The Crab strategy allows users to earn money (yield) by shorting Squeeth regardless of whether ETH will rise or fall. In other words, Crab v2 is a Delta neutral strategy.
The Crab position is:
Long ETH
Short Squeeth (Returns in USD, i.e. Yield!)
At the highest level, the Crab strategy makes money if ETH moves up or down by less than x% between rebalances. This range is known as the profit threshold, and it changes based on Squeeth's funding.
In order to maintain the neutrality of the market, the treasury maintains a balance at around 16:30 UTC every Monday, Wednesday, and Friday (or when the price of ETH fluctuates sharply).rebalance during crab auction。
The main reasons for users to participate in this auction are,auctionTrades are generally performed at better prices, and users can trade larger sizes with less slippage.
Ideal market conditions for Crab
When the price of ETH fluctuates in a relatively stable range with low volatility (the price of ETH is calm), this is the ideal sideways market condition for the Crab strategy.
More specifically, the Crab strategy performs best in periods when Squeeth's realized volatility is less than Squeeth's implied volatility. In other words, the strategy believes that the current implied volatility is too high (the market predicts that ETH is too high), or that the actual volatility will be lower than the market expects. This is a classic "short volatility" position.
Therefore, the ideal market conditions to deploy the Crab strategy are when the price of ETH does not rise or fall too much between rebalances.
ETH can go up and down, but it needs to be within a relatively stable daily range (relative to volatility).
The goal of the Crab strategy is profit in dollars. The dollars earned by this strategy are the result of shorting a certain amount of oSQTH. When the price of ETH rises, it tends to dump ETH, trying to preserve its dollar value.
Another benefit of Crab is that it can accumulate ETH in a bear market. Since its goal is to gain USD value, it tends to accumulate more ETH when ETH drops. (This is the unrealized accumulation of ETH. In a bear market, you need to exit the strategy to realize the increase in the amount of ETH.)
In short, when using the Crab strategy correctly:
ETH up = earn USD, lose ETH
ETH flat = earned USD
ETH down = earn USD, accumulate ETH
How to Deposit Opyn's Crab Strategy
Go to https://go.squeeth.com/bankless
connect your wallet
Press the Approve button
Sign txn.
Enter the amount of ETH you want to deposit, press the "Deposit" button, and sign the transaction.
additional resources
Strategy 2: Rysk DHV
Rysk is an on-chain DeFi options protocol. Rysk's first product is DHV (Dynamic Hedging Vault), a new option AMM that generates uncorrelated returns for its liquidity providers by trading options while targeting Delta neutrality.
Rysk DHV enables options trading (vanillas, strangles, and straddles), effectively acting as an on-chain market maker for options and, to some extent, an on-chain automated options trading desk.
Under efficient market conditions, vaults will dynamically hedge themselves by trading other options, spot or perpetual contracts to rebalance delta or reduce exposure. This mechanism incentivizes trading options by automatically adjusting option pricing, thereby reducing DHV's portfolio Delta back to 0, thereby providing opportunities for option arbitrage and cheaper option exposure.
Ideal market conditions for Rysk DHV
Rysk's DHV will have option exposure and is expected to be net short volatility. While it is theoretically possible for vaults to be volatile over the long term, this is unlikely due to expected demand from market participants.
As a net short volatility, the ideal market for DHV is a market with higher volatility for ETH. Statistically, realized volatility is lower than implied volatility, which is one of the sources of income for Rysk DHV. The other is to get spreads from options stream. Liquidity providers benefit from both.
important details
Depositors deposit USDC into Rysk DHV, and the income is denominated in USDC.
By trading ETH options and targeting Delta neutrality, DHV is able to generate USD returns that are independent of ETH market movements.
DHV trades both long and short options, but is most likely short volatility. There are risks associated with this and losses may occur. By staking USDC and dynamically hedging the treasury book, DHV aims to significantly reduce the directionality of ETH and maintain a stable, low-volatility daily return for investors.
How to use Rysk
Disclaimer: This is brand new technology. Errors may occur. Please use at your own risk!
Rysk DHV is currently available in its Alpha release. Therefore, it is only available to those who sign up for alpha and wish to test this new strategy.
For those brave enough, you can find it hereSign up for the Alpha Club。
bonus resources
Strategy 3: Manual Delta Neutral Strategy with Options
In addition to the two automated DeFi strategies mentioned above, manually creating Delta-neutral strategies by trading options allows traders to profit from time decay and volatility.
image description
Source: Projectfinance.com
Remember, a delta neutral position is one with an overall delta of zero.
A short straddle consists of a call and a put, where the negative delta of the put offsets the positive delta of the call. Both options have the same underlying asset and the same expiration date. A short straddle is profitable if the underlying asset trades within a narrow range between the breakeven points (similar to the Crab strategy).
This approach minimizes the price movement of the option relative to the underlying asset.
The maximum profit on a short straddle is limited to the total premium received less transaction costs. The maximum profit is realized if the short straddle is held to expiration with no change in the price of the underlying. Potential loss on the upside is unlimited (due to shorting the call option).
On the downside, the potential loss is the strike price -0, as the underlying asset could fall to zero.
While the delta of a short straddle may be 0 when the position is opened, when the price of the underlying rises, the trader must reset the delta of the entire option strategy to 0 by purchasing a small amount of the underlying. On the other hand, when the price of the underlying falls, the trader must sell some of the underlying.
Irrespective of transaction costs, if a trader can buy/sell a small amount of underlying each time the underlying moves, they will have a perfect hedge. However, transaction costs prevent continuous rebalancing in CeFi, more so in DeFi.
an open design field
It's worth noting that delta neutral strategies are not limited to trading options! You can implement various Delta neutral strategies using other financial instruments that exist in DeFi today.
Here are some examples of other delta neutral strategies:
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