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FxWirePro: Quanto perpetual swap hedging series - Long ETH/USD and hedge

Amid the crypto market downturn which began after the news of the US Securities and Exchange Commission’s (SEC) delayed decision on an ETF product approval, BitMEX has announced the launch of two derivatives products, namely, ETHUSD perpetual swaps and UPs & DOWNs to meet market demand.

While hedging a quanto perpetual swap is not straightforward. The added component of correlation risk between two crypto assets complicates things. 

Let’s consider ETHUSD
Assume ETHUSD trading price at $500 level

Multiplier: 0.000001 XBT
.BETH (ETHUSD Spot Index): $500
.BXBT (XBTUSD Spot Index): $10,000

Assume that you are lifted for 100,000 contracts of ETHUSD.

First let’s compute your currency exposures:

XBT Value = $500 * 0.000001 XBT * 100,000 = 50 XBT
ETH Value = XBT Value/(.BETH/.BXBT) = 1,000 ETH

Next you hedge your ETHUSD exposure by shorting 1,000 ETH at the spot price. Assume you can match the current .BETH Index price on your purchase, and there is no cost to borrow ETH for this short sell.

You have hedged your underlying currency exposure. At this point your exposure is perfectly hedged. However, as the price of ETHUSD changes, your P&L on ETHUSD will be in XBT, while the P&L on your ETH hedge will be in USD.

Well, let’s now glance at two extreme scenarios:

Scenario 1: .BETH Rises and .BXBT Falls

.BETH and ETHUSD rises to $750
.BXBT falls to $5,000
ETHUSD P&L = 25 XBT, USD Value $125,000
ETH Spot USD P&L = -$250,000
Net USD P&L = -$125,000

In this instance, the correlation between the USD value of XBT and ETH is -1. They moved in a perfectly negatively correlated fashion, and you lost money.

Scenario 2: .BETH Rises and .BXBT Rises
.BETH and ETHUSD rises to $750
.BXBT rises to $15,000
ETHUSD P&L = 25 XBT, USD Value $375,000
ETH Spot USD PNL = -$250,000
Net USD P&L = $125,000

In this instance, the correlation between the USD value of XBT and ETH is +1. They moved in a perfectly positively correlated fashion, and you made money.

While the short ETHUSD position + Hedge profited when correlation rose, and lost when the correlation fell. Due to the flat ETHUSD vs .BETH basis, the entry price assumed a correlation of zero between the two cryptos. Courtesy: BitMEX

Currency Strength Index: FxWirePro's hourly BTC spot index has shown -111 (which is bearish), while hourly USD spot index was at 117 (bullish) while articulating at 09:31 GMT. 

For more details on the index, please refer below weblink: 

http://www.fxwirepro.com/currencyindex

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