Original author: BitMEX
gm, welcome back to our weekly options alpha series. Last week, we discussed how Bitcoin options may be undervalued compared to the 2020-2021 bull run. We mentioned that traders could capture the potential volatility spike by setting up straddle strategies.
In this article, we will show you a clever way to take advantage of big moves in ETH price without using options - this method allows traders to capture both BTC performance improvements and big moves in ETH at the same time. This strategy is in some ways more effective than setting up a straddle!
Let’s take a deeper look.
BitMEX’s Quanto Perpetual Contract: A Unique Derivative
Quanto perpetual contracts, such as the ETHUSD quanto perpetual contract on BitMEX, provide a unique opportunity for traders in the crypto market. These contracts are settled in BTC, which means that profits and losses are paid in Bitcoin instead of USDT or ETH.
How is it similar to options?
Quantos unique settlement mechanism, combined with the strong correlation history between BTC and ETH, introduces an element of convexity to trading. Similar to options, this convexity allows traders to potentially profit from significant price movements in either direction. By strategically combining two perpetual contract positions, traders can gain convex exposure, potentially benefiting from large moves up or down. This feature distinguishes quanto perpetual contracts from traditional delta-1 perpetual contracts, which typically provide linear returns. Using quanto perpetual contracts, traders can create portfolios that are potentially profitable in volatile markets, regardless of the direction of price movements, as long as the movement is large enough to overcome costs.
To illustrate the unique payoff structure of this trade, let’s look at a simulation:
Open a quanto contract position of 1 ETH, and use 1 ETH of USDT to settle the ETH perpetual contract short:
If the ETH price remains relatively stable, the overall profit and loss will tend to be low
But if ETH experiences significant price movement in either direction, the potential for significant profits increases significantly.
Note that the simulation was created when ETH was trading around $2,500 and the ETH/BTC correlation was 0.6
This trading strategy presents a great opportunity for traders:
You can capture both rising and falling market conditions at the same time, and you can make money no matter which direction the price fluctuates sharply
Particularly suitable for use when market uncertainty is high or volatility is expected to increase
However, there is a major risk to this strategy:
Transaction Risk
The biggest challenge comes from funding rates
Normally, ETHUSDT shorts can get about 0.01% funding fee per cycle
However, the funding fee for ETHUSD quanto is often more than 0.01% (0.05% at the time of writing this article)
The difference between these two rates is the cost of holding the position.
Considering this cost structure, entry timing becomes particularly critical:
The best time to enter a market is before you expect a big move
Remember, as long as the market fluctuates significantly, there is always an opportunity to make money whether it goes up or down.
If these key points are mastered, traders can make full use of the characteristics of quanto contracts and profit from market fluctuations while controlling risks.
How it works
Specific transaction steps:
Long 1 ETH ETHUSD quanto perpetual contract on BitMEX
Short 1 ETH on BitMEX ETHUSDT perpetual contract at the same time
Performance in different situations:
1. If ETH/USD rises by 10%:
Quanto Long: Earn 10% in Bitcoin
USDT perpetual short: 10% loss in USDT
End result: If BTC/USDT also rises, you can make money because the gains denominated in Bitcoin will exceed the losses in USDT
2. If ETH/USD drops 10%:
Quanto longs: 10% loss in Bitcoin terms
USDT Perpetual Short: Earn 10% in USDT
End result: If BTC/USDT also falls, you can make money because the gains in USDT will exceed the losses denominated in Bitcoin
Key risks:
1. Funding rate expenses: The funding rate of ETHUSD quanto is usually higher than that of ETHUSDT. If you hold a position for a long time, the cost in one year may exceed 20%.
2. ETH/BTC correlation: Changes in the ETH to BTC ratio can greatly affect profitability. A stronger BTC price is good for this strategy, and vice versa.
Summarize
Using BitMEXs quanto and USDT perpetual contracts is more cost-effective than playing options directly. This strategy is particularly suitable if you think ETH may fluctuate violently in the short term, but you are not sure whether it will rise or fall.
