Leverage for long positions in exchanged-traded market free from liquidation and high interest
Long traders are often troubled by the high risk of liquidation and high interest in the exchange-traded market. This article will put forward a corresponding solution.
The prospect of long-term BTC price increase is a mainstream consensus in the crypto market.
Traders always wish to own more BTC spot. If they have almost exhausted their money, they will still wish to add leverage to their BTC.
Leverage can be added in the exchange-traded market and in the OTC market.
Adding leverage in the OTC market means financing with own’s own credit free of collateral. Alternatively, traders can take their property as collateral to obtain financing. The advantage lies in the freedom from liquidation threatened by a dramatic drop in BTC price that would result in loss of positions.
Most commonly, leverage in the exchange-traded market is added by using BTC itself as margin to long positions with contracts. Alternatively, traders can use BTC as collateral to borrow USDT for consumption or buy BTC spot to increase long positions.
Leverage in the exchange-traded market is easy to obtain, but its disadvantages are also obvious.
First, the interest rate is high. In a bull market, futures need to undertake an annualized premium of about 20%. The funding rate of a perpetual swap can easily reach an annualized rate of 50% (8-hour rate of 0.05%), and the USDT borrowing rate can often exceed 15%.
Second, what is more fatal is that if the BTC price drops significantly like what happened on March 12, 2020 and May 19, 2021, the one-time leverage will trigger liquidation when there is a cumulative decrease of 50% due to the depreciation of USD with bitcoin as collateral. Once traders’ positions are closed out, subsequent BTC price rebound would have nothing to do with them.
I have seen a lot of such cases in the market. What a pity!
In this article, I will introduce to you a solution to add leverage for long positions in exchanged-traded market free from liquidation and high interest.
That is realized using options as a tool together with futures.
There is a need to mention that the solution proposed herein is not financial advice. Please do your own research and risk assessment.
Suppose I have 1 BTC in the exchange-traded market, and I wish to use leverage to long the position.
First, I long the 31-Dec-2021 futures equivalent to 1 BTC with an annualized premium of around 10%.
Now the underlying price is around 57,800 USD. If the price drops by 20%, it will decrease to 46,000 USD. For long positions of coin-standard contracts, the par value of the coin is amplified. So when the underlying price drops by 20%, the 1 BTC long futures will become 1/0.8 = 1.25 BTC long futures.
Let’s take a look at options. Today is November 22, 2021. Let’s analyze the quote of the options expiring in 11 days (3-Dec-2021 options).
I can buy 1.5 BTC put options at the strike price of 46,000 USD to protect the original 1 BTC long futures (as it will become 1.25 BTC long futures when the underlying price drops to 46,000 USD, there is a need for overprotection). The price of each put option is 0.0045 BTC, and 1.5 put options will cost a premium of 0.0068 BTC.
By far, the cost of the whole position comes from two sources:
1. The premium expense of 0.0068 BTC of the put option. The annualized rate is 0.0068x 365 / 11 = 22.56%.
2. The annualized premium of 10% from 1 BTC long futures. Without considering premium fluctuations and apportioning this to 11 days, the cost would be: 1 x 10% x 11 / 365 = 0.0030 BTC.
Adding up the two sources of cost leads to an 11-day cost of 0.0098 BTC or an annualized rate of 32.56%.
Good. Now let’s work some magic to let the cost disappear.
An 10% price increase from 57,800 would lead to a price of 63,580. Let’s take a look at the call option with a strike price of 63,000. Selling the option can obtain a premium of 0.0210 BTC.
After selling the call option, the return on long futures will be capped at 10% within 11 days.
The return is that the time value balance of the whole position will become: 0.0210–0.0098 = 0.0112 BTC. This is the return for the 11 days. If we want to get the annualized rate, we can simply multiply it by 365 and then divide it by 11 to arrive at 37.16%. In this case, we can not only save interest payment, but also receive interest with an annualized rate of 37%.
Certainly, this has to do with the quality of the option itself (i.e. the implied volatility). If the option value drops, the interest will also drop. Traders should bear in mind their original intention of obtaining one leverage for long positions for free. It would certainly be good to collect some interest, but it is still good if they do not have to pay interest.
Will such positions miss one step? No.
A back test of the weekly quotes so far in 2019 shows that the average increase rate of the increasing weeks was 7.5%, and the strike prices at which calls were sold were 10% higher than the price of spot, which ensured a relatively good value for money. Even if the underlying price goes up by 20% in a week, causing you to make 10% less, you can simply sell the call option whose price is 10% higher than the new price next week. Only the return on futures will be capped, and the margin of spot will not be capped. Just hold the futures until the price inceases to higher levels next week.
Before the expiration of the futures, you can use the futures swap in the automated trading tool on the Greeks.live website to close front-month long futures and open back-month long futures.
By using the tool “Position Visualization” in the menu bar of the Greeks.live website, you can see the profit and loss curve of this position portfolio as follows.
You can even earn BTC if there is a shocking drop in BTC price.
Remember to apply for portfolio margin when opening a sub-account for this position, so that profitable positions can cover the margin of losing positions.
If there is a big drop and a net loss, reduce the futures positions to a new and smaller net level when opening rolling positions next week. This can effectively reduce risk. Besides, you can also reduce the put options accordingly to reduce expenses.
Following these steps and back testing with year-to-date 2019 data yields the following net worth curve.
Back test 1: The total time value is even.
Back test 2: The total time value is a weekly rate of 0.50% and an annualized rate of 26%.
This strategy solves two problems, namely the risk of liquidation and high cost of leverage for long positions in the exchange-traded market.
However, since this is a long strategy, you may well recognize that in the context of a big bear market as well as a major correction, going long by adding leverage will inevitably undermine the net worth significantly.
It is up to your wise judgment when to adopt such a tool.
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November 22, 2021