Recently, in a famous community forum in the cryptocurrency circle, someone expressed dissatisfaction with the fund returns issued in the community (not issued by the community itself) and subsequent follow-ups, posting such a message (many brothers might know where this is from):
Subsequently, the fund manager also posted a response:
In the response post, the fund manager mentioned:
There is no need to discuss who is right or wrong in the online debates here. Let's talk about something interesting, which is what the fund manager refers to as the mysterious 'hedging strategy' and the peculiar profit and loss conditions below.
To understand hedging strategies, the key lies in the word 'hedge', which actually means 'relative' or 'paired'. As the fund manager said, a hedging strategy requires holding both long and short positions (long and short are relative and paired), and then the hedging strategy does not profit from predicting market trends (meaning it is unrelated to market fluctuations), but profits from 'mispricing' of long and short positions (this is important).
This still sounds abstract, let's clarify it with a specific example. Most of the time, we all feel that when Bitcoin rises, Ethereum also rises, although the degree of increase is not exactly the same; when Ethereum falls, Bitcoin also falls, although the degree of decrease is not quite the same. So, people might wonder if there is any relationship between the prices of Bitcoin and Ethereum.
This conjecture is important. Let's verify it. I have the daily closing data for Bitcoin and Ethereum for the entire year of 2021 (don't ask me why I didn't use the recent data; it's just that I happened to have this set of data):
A simple idea is that Bitcoin and Ethereum rise and fall together, so there is a specific relationship between their prices. For example, on January 1, the price of Bitcoin was 29337, and Ethereum was 730, so roughly, 29337=730*40+137, meaning the price of Bitcoin is 40 times that of Ethereum plus a little. If we verify, on January 2, the price of Bitcoin was 32200, and Ethereum was 775, 32200=775*40+1200, which is not far off. Thus, a bold idea forms in our minds: the price of Bitcoin should equal 40 times the price of Ethereum. What is the use of this idea?
On December 7, 2021, the prices of Bitcoin and Ethereum were as follows:
50577=4305*12-1083, at this point, Ethereum and Bitcoin only differ by 12 times, while our idea is that Bitcoin should be 40 times that of Ethereum! Clearly, according to our view, Bitcoin is too cheap compared to Ethereum, while Ethereum is too expensive compared to Bitcoin.
According to the principle of 'buy low, sell high', on December 7, we should go long on the 'relatively' cheaper Bitcoin (going long 1 Bitcoin, coin-based contract), and short the 'relatively' more expensive Ethereum (shorting 40 Ethereum, coin-based contract). Assuming we held these two contracts until yesterday (temporarily ignoring costs like funding rates), what would happen? The known price yesterday was (actual price):
105029=2509*41.86, Bitcoin has returned to 40 times Ethereum! At this point, your contract profit situation:
Bitcoin long position: 105029-50577=54452U
Ethereum short position: (4305-2509)*40=71880U
Total profit 54452+71880=126332U
At this point, let's open our minds and imagine three situations: the overall market price soaring, the market price plummeting, and the market price not changing much (simulated prices):
The prices in these three situations are all made up, but they all satisfy the formula Bitcoin=Ethereum*41.86, so:
Soaring:
Bitcoin long position: 314787-50577=264210U
Ethereum short position: (4305-7520)*40=-128560U
Total profit 264210-128560=135650U
Plummeting:
Bitcoin long position: 14232-50577=-36345U
Ethereum short position: (4305-340)*40=158640U
Total profit 158640-36345=122295U
Not much changed:
Bitcoin long position: 146510-50577=95933U
Ethereum short position: (4305-3500)*40=32240U
Total profit 95933+32240=128173U
We can see that regardless of whether the price goes up or down, as long as the price relationship eventually returns to the pattern we are thinking of (40 times), our profits stabilize around 120-130 thousand U (the slight difference is due to the last price not exactly reaching 40 times).
This is the truth about the 'hedging strategy'. In summary, we first assume that the prices of the two currencies follow a fixed pattern. When this pattern is broken, we go long on the relatively undervalued one and short the relatively overvalued one. When the pattern returns to normal, we can profit from the price deviation when it 'does not conform to the pattern', which is what we previously referred to as 'mispricing'.
At this point, let's take a look at what the fund manager said, it can be easily understood:
When the rise of long positions is greater than the rise of short positions, the strategy is profitable;
(Bitcoin rose significantly, and more than Ethereum, an example of soaring)
When the rise of short positions is greater than the rise of long positions, the strategy incurs losses;
(Bitcoin rose, but less than Ethereum, and did not return from 11 times to 40 times, instead became 7 times, 8 times)
When the decline of long positions is less than the decline of short positions, the strategy is profitable;
(Ethereum fell, and it fell much more than Bitcoin, a dramatic example)
When the decline of long positions is greater than the decline of short positions, the strategy incurs losses;
(Bitcoin fell, and fell much more than Ethereum, not returning from 11 times to 40 times, instead became 7 times, 8 times)
In fact, we can also add two points:
When long positions rise and short positions rise, the strategy is profitable;
(Bitcoin rose, Ethereum fell, an example of not much change)
When long positions fall and short positions fall, the strategy incurs losses.
(Bitcoin fell while Ethereum rose, and the price difference did not return from 11 times to 40 times, but instead became 7 times, 8 times)
I believe everyone has also noticed that once this strategy is formed, it is unrelated to market fluctuations, but related to the 'relationship' we guessed (40 times). If the guess is accurate, profit can be made. However, is it really that easy?
Let's chat next time. 😘