Cash And Carry: Building Delta Neutral Strategies
TLDR;
- Inefficiencies exist in the crypto perpetual market, and traders can take advantage of mispricings and earn a profit
- The cash and carry trade is a profitable strategy that allows traders to take advantage of the discrepancies between perpetual and spot price
- Traders can utilize Kwenta to take arbitrage positions without exposing themselves to high fees
- Perps V2 technology allows users to trade a wide variety of assets while paying minimal fees
The Cash and Carry trade is a lucrative approach for traders seeking to capitalize on market pricing inefficiencies. Below, we will explore the basics of cash-and-carry trading and how it works, with examples of how traders can utilize Kwenta to profit from the market. Specifically, we will look at how traders can use this strategy to take long positions in assets while simultaneously selling associated futures derivatives and earn the funding rate when the market is long-skewed.
What is the funding rate?
The funding rate is a recurring payment that traders pay or receive based on the disparity between perpetual contracts and spot prices. This rate is determined by the skew of the derivative and the extent to which the perpetual contract deviates from the spot market. When a Perpetual Swap contract trades at a premium, the skew on Kwenta has turned positive. Similarly, when the Perpetual Swap contract trades at a discount, the skew on Kwenta has turned negative. On Kwenta, premium and discount will always match the skew, but funding may not.
What is the cash and carry trade?
A cash-and-carry trade is a popular strategy that allows traders to capitalize on market pricing discrepancies. Typically, this involves taking a long position in a token while simultaneously selling the associated perpetual contract. This opportunity often arises due to mispricing between the perpetual and spot markets. By purchasing the spot version of the token and shorting the perpetual contract, investors can earn the funding rate when the market is long-skewed and shorters are paid to short and also take advantage of premium/discount on a pair.
Understanding the cash and carry trade.
Cash and carry trades involve taking a spot-long position in a token while being short on the perpetual contract, meaning that the overall value of the trade is not affected by small changes in the price of the underlying asset (delta neutral). By holding this position, the trader can earn the funding rate of the associated asset while not being exposed to any price movements. The funding rate is used to rebalance the price of the derivative to move the price closer to the spot price. This strategy can be profitable under a positive funding rate, where long positions receive payments from short positions due to the funding rate.
How to identify potential trades.
Identifying cash-and-carry trades involves analyzing the pricing discrepancies between the spot and futures markets. Typically, when the spot price is lower than the futures price, a cash-and-carry opportunity exists. In the scenario below, traders can purchase the underlying asset at the lower spot price and simultaneously short the perpetual contract at the higher futures price. As a result, the investor earns a profit on the price difference and the funding rate, which is paid to short sellers of the futures contract. Identifying these opportunities requires traders to keep vigilant and find market mispricing using various market monitoring techniques. Successful cash and carry traders often have access to up-to-date market data and tools to help them identify these opportunities quickly and capitalize on them before they disappear. For example, traders can monitor sREKT twitter account, which tweets Kwenta’s liquidations and create opportunities for large premiums. Kwenta has the market price and the index price listed at the top of each market page. The index price should be a close reflection of the asset price on other exchanges and an opportunity to identify trades.
Let’s take $ETH for example; it is currently trading at $1637 on Kwenta and at the same price on 1inch as visible in Figure 1 and 2. The current funding rate for ETH-PERP on Kwenta is positive 0.012117%; this means that all the long positions pay the short positions this percentage on an hourly basis. Of course, the funding rate fluctuates and so does the return that a trader gets. In this case, it yields 106% APY before any trading fees. If there is a significant price discrepancy between the perp price and the spot price, it can be sold once the perp price rebalances. Otherwise, the trader can hold the perp and collect the funding rate.
In this example, to carry out the cash and carry trade, a trader purchases $10,000 in spot ETH and short the equivalent on Kwenta. It is possible to utilize Kwenta’s outstanding capital efficiency and place a 5x leveraged trade where the initial deposit is only $2,000.
The total fees on this trade will be $52, covering the opening cost and the closing cost. They are making a profit of $29 daily and only waiting under 2 days to break even.
It is also possible to profit from the premium/discount of the perp as On Kwenta, premium and discount will always match the skew. Hence traders are able to arbitrage the difference between spot price and the underlying if the market has mispriced the perpetual contract. It is especially profitable with Kwenta as traders are able to utilize its phenomenal capital efficiency to open trades. To earn profit from a premium, the premium must be sold down by traders who enter after you, not your own trade. A good rule of thumb is that the highest chance of profit comes from moving the market skew no more than halfway to neutral. For example, if the imbalance in a market is a $1M higher long OI, then a short position of $1m or less gives the highest chance of realizing a profit, which becomes possible as later traders push the skew increasingly neutral.
As with any strategy, there are risks involved. It may not always be possible to execute the trade due to open interest limits and/or spot liquidity being thin. Hence it is extremely important to consider the liquidity available on both sides of the trade. Furthermore, traders must consider the market impact of the trades, as profitability decreases the higher the price impact your trades have. It is important to note that traders expose themself to fluctuations in the funding rate which can deem the strategy unprofitable.
What is Kwenta?
While the fundamental concepts of this article can be applied to many different leveraged trading venues, traders may find Kwenta to be an excellent venue for delta neutral strategies.
Kwenta is the cryptocurrency perpetual contract platform of the future that runs on Optimism and is powered by Synthetix Perps. The platform is designed to provide users with a fast and easy trading experience. Kwenta offers a wide range of perpetual contracts fo cryptocurrencies such as Bitcoin, Ethereum, and other popular altcoins. Traders have access to a diverse set of trading pairs with up to 25x leverage. Additionally, the platform provides users with advanced trading features such as stop-loss orders, take-profit orders, and more. With the introduction of Synthetix Perps V2, Kwenta is efficient and offers low trading fees.
Furthermore, Kwenta offers an unrivaled intuitive user interface and streamlined trading experience, making it an excellent choice for traders looking for a user-friendly platform for trading. Kwenta also has a fee rebate system by which traders earn Kwenta when they trade on the platform. With such low fees and the introduction of fee rebates, there is no better time to start trading on Kwenta.
