How to Trade Perpetuals with Delta-Neutral Crypto Strategies

How to Trade Perpetuals with Delta-Neutral Crypto Strategies

Given that the cryptocurrency market is highly volatile, delta-neutral strategies should be part of your portfolio. They help limit your exposure to price risk in a trading environment where many assets can plunge 90% in their value within days. 

In this latest GRVT Academy series, we will guide you through some delta-neutral tips and strategies - focusing on perpetual futures and funding rates. 

First up, a couple of definitions you need to know in order to understand the trade: 

  • Perpetual futures: derivative contracts without an expiration date, often called “perps”. They track the price of an underlying asset, allowing traders to speculate and take advantage of short future price movements. Traders can hold their positions indefinitely, offering flexibility and eliminating the need for contract rollovers.
  • Delta-neutral trade: a trading strategy that involves multiple positions to neutralize the impact of underlying asset fluctuations on profit and loss (PnL). However, you will still be exposed to other factors such as basis, funding rates, and volatility.

Funding rate mechanism

Perpetual futures stand out from traditional futures due to the presence of funding rates - a key aspect in delta-neutral strategies. Note that:

  • If the price of the perpetual futures contract is trading at a premium (i.e. higher than the spot market), long traders pay the funding rate to short traders
  • If the price of the contract is trading at a discount (i.e. lower than the spot market), longs receive the funding rate from shorts

As the price of the perpetual futures contract deviates from the spot market, the corresponding funding fee increases. Thus, traders are incentivized to balance the market and prevent large deviations between the futures and spot prices. 

Delta-Neutral Strategies with Perps

In the context of perpetual futures, traders can use a delta-neutral approach by carefully managing their long and short positions. By doing so, they can leverage funding rates to generate consistent returns.

Here are some tips: 

  1. Monitor Funding Rates:
    Regularly check the funding rates of your perpetual futures contracts. Platforms typically provide this information, and understanding their dynamics is crucial for executing a delta-neutral strategy.
  2. Identify Market Imbalances:
    Analyze market conditions for substantial deviations between the perpetual futures contract and the spot market. This could indicate a potential funding opportunity.
  3. Execute Delta-Neutral Positions:
    Offset your delta exposure by simultaneously taking long and short positions. The goal is to profit from funding rate differentials rather than relying on market direction.
  4. Adjust Positions:
    Adjust your positions according to market conditions. If the perpetual futures contract starts trading at a premium, consider reducing your long position and increasing your short position, and vice versa.
  5. Manage Risks:
    Implement strong risk management strategies to protect your capital. Set stop-loss orders, monitor leverage levels, and be ready to exit positions in unfavorable market conditions. 

Example of Funding Rate Arbitrage 

A widely-used delta-neutral trade strategy in crypto is funding rate arbitrage. This is when you simultaneously execute two trades in opposite directions with equal quantities. 

Assume the current BTC price is 20,000 USDT and the funding rate is 0.04%. You want to use 4,000 USDT for funding rate arbitrage with 1x margin:

  1. Buy 2,000 USDT worth of BTC spot and short 2,000 USDT worth of BTC perpetual contract.
  2. Assume funding rates remain consistent every 8 hours, you will receive: 
    2,000 USDT x 0.04% = 0.80 USDT
  3. If you collect 0.80 USDT every 8 hours, you will receive 2.40 USDT per day. Your annualized return calculation will be: 
    2.40 x 365 / 2,000 = 43.8% 

The aim is to offset profits and losses in both spot and perpetual contracts, ultimately earning a funding fee income. 

Funding Rates at GRVT

Unlike most typical exchanges that apply funding rates on an eight-hourly basis, GRVT uses a one-minute interval. Along with the platform’s use of zero knowledge proofs, there are some benefits offered by this approach:

  • Funding payments occur faster and more regularly 
  • Funding payments are directly exchanged between traders, meaning GRVT’s exchange does not receive or pay any part of these payments
  • More frequent exchange of funding payments contributes to a more stable balance between the perpetual contract price and the spot market price

GRVT’s funding rate mechanism also offers real-time calculation and settlement, ensuring immediate responsiveness to market conditions. Funding rates remain current and accurate. They are also continuously settled, instantly reflecting changes in positions - whether from trades or adjustments - in your realized PnL. 

Mastering Delta-Neutral Strategies with Perpetuals

Delta-neutral trading with perpetual futures based on funding rates can be a sophisticated yet rewarding approach for experienced traders. 

By skillfully balancing long and short positions as well as capitalizing on funding rate differentials, traders may achieve steady profits irrespective of market trends. However, the strategy still carries risks. Traders should consider factors such as position size, liquidation risk, market depths, and trading fees.

Simply put - stay informed, adapt to market changes, and use effective risk management.

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