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Hedging Ethereum Exposure with Short ETH Perp paired with Long ETH option
As funding fees for perpetual futures traders soar to triple digits on an annualized basis, traders can entertain an approach involving a combination of shorting perpetual futures contracts while simultaneously going long on options contracts. With Ethereum’s (ETH) annualized funding rate for long perpetual contracts at a staggering 115% on March 5th, this strategy could be fruitful for those looking to take advantage of heated funding across perpetual trading exchanges.
The Cost of Going Long on ETH Perpetual Futures
As you may know, perpetual futures contracts, unlike traditional futures, do not have an expiration date, allowing traders to hold positions as long as they desire. This flexibility however comes at a cost, known as the funding rate. In essence, when the funding rate is positive, as in the case of ETH’s current 115% annualized rate, long position holders are required to pay this fee to their short counterparts. This funding can be burdensome for long traders if the rate remains elevated.
The Opportunity in Options
Conversely, options provide a different form of market engagement. For example, the ETH $4,000 call strike, currently trades at 81% IV and a premium of .31 ETH. By purchasing this December call option, traders are spending .31 ETH to be long this contract into December expressing further upside bullishness.
A Hedged Approach
The combined strategy would involve shorting the ETH perpetual future to collect the hefty 115% annual funding rate while simultaneously holding a long position in the ETH $4,000 December call option. This approach allows traders to maintain a bullish stance on the market, with the potential for upside should ETH’s price soar towards the strike price as December approaches.
This dual approach creates a hedge, where the risks associated with the perpetual futures’ funding fees are balanced by the potential gains from the options market.
Considerations and Risks for Traders
The cryptocurrency market’s high volatility means that both perpetual futures’ funding rates and options’ IV can fluctuate dramatically. For example if the funding rates drop sharply, it may not be worthwhile to short the ETH perpetuals to fund or cheapen the options contract.
If the market trades sideways, this might be good for your short ETH perpetual leg; however this drift may erode the IV in the December options contract.
This trade also requires traders to pay attention to their deltas. If the trader is aiming to remain delta neutral simply to collect the 115% funding fee annualized it is vital to monitor portfolio delta as time passes. If the trader has a bullish bias perhaps the short perpetual could be smaller in size vs the long ETH call option to prioritize a more positive delta.
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