Spread Trading Inverse Futures

Discussion in 'Options' started by MrMuppet, Dec 5, 2018.

  1. MrMuppet


    I wasn't quite sure were to put this, but since some options guys here know how to math, I figured the options subforum was best for this. I thought about posting this to the eggheads at willmot and nuclearphynance, but wanted to have a practical solution :)

    Currently I'm dealing with quite an interesting challenge: How on earth do I hedge the non-linearity of an inverse futures spread.

    Let me explain.

    A normal spread trade is long product A/short product B. Both have the same tick value and are denominated in the same currency. Tick value is static. So you can express the entire trade as A-B= Spread and your P/L is Spread(sold)-Spread(bought) x Tick value x size. Linear=simple.

    Inverse futures follow a 1/x function and are not linear. Like for example if you trade an EUR/USD - CFD with a bucketshop and they denominate the P/L in Euro instead of USD or BitMEX' XBTUSD, which is quoted in USD but settled in XBT.

    Because their Tick value is not static, the P/L calc is -(1/Selling price - 1/buying price) x size x current underlying price (when you want to peg the trade against the USD)

    This means, your spread P/L calculus is this:

    (-(1/selling price Leg1 - 1/buying price Leg1)-(1/selling price Leg2-1/selling price Leg2)) x size x current underlying price

    The characteristics of this beast are quite interesting.
    A change in the spread price generates deltas and amplifies convexity depending on the underlying price.

    Picture worth more more than thousand words (Spread price is z axis from -200 to 200, x axis is underlying price, y axis is P/L)

    As you can see, it's pretty nasty to trade this thing. If you're on the wrong side, you get your balls kicked twice. However, I like it a lot since I could not find anything about them, which means there's a lot of edge to be had plus you can gamma scalp the upside :)

    Has anybody an idea on how to isolate the spread price and hedge changes in the underlying?
    I mean it kinda looks like a split strike synthetic that gets more gamma with negative underlying returns instead of lower vol.
    At the moment I hedge when I feel like I need to, but I'd love to just do a lock, stay away from the screen and let it ride.

    Input is appreciated...could also be that I'm wrong somewhere in my asumptions.


  2. 2rosy


    take the reciprocal of one leg. not sure where nonlinear comes in
  3. MrMuppet


    Last edited: Dec 5, 2018
  4. 2rosy


    you only need the reciprocal when calculating. actually, in your eur/usd vs cfd (usd/eur) just convert one leg to same currency. or buy (or sell) both legs and leave as is. not sure what the issue is
  5. MrMuppet


    Those are fixed contracts. You cannot convert an XBTUSD into a USDXBT contract the same way you cannot convert an ES futures contract into a 1/ES futures contract.

    With currencies, arbing bucketshops is easier since you definitely can trade the reciprocal of USD/EUR but you find these things everywhere because customers like the fact that they can trade in their home currency.

    Just as an example, let's say you want to spread DEC/MAR of one of these babies here: https://www.bitmex.com/app/trade/XBTUSD
    Last edited: Dec 5, 2018
  6. MichalTr


    @MrMuppet Maybe it's not so smart or automatic method but for manual trading on BitMex can be useful:

    In your example you want to trade DEC/MAR Bitcoin spread on BitMex, so as I understand the only problem is that accounts on BitMex are settled in BTC (I don't see the problem with contracts priced in USD becouse it's a spread). When you fund your account with BitMex in fact you are going long BTC/USD. So what you can do is just to short XBTUSD on BitMex with the amount of dollars equal to you account size. As long as you keep this position open your account "is in" USD (you are cutting out the BTC price risk). In same time you can trade futures spreads of BTC contracts. If you hedge your account like that, of course from time to time (preferably regularly, eg at the settlement or when closing positions) you need to adjust your short hedge, depending on whether your spread transactions give profits or losses (to hedge the USD value of your profits or to don't have too short position if you loose money). And remember about interest rate if you have this short open (at the moment of writing this post the rate is positive so longs will pay you). In fact if the rate will be long enough you can also earn a little by just hedging your account.

    If you are in automated trading I don't have idea for this :D
  7. MichalTr


    Btw: yummy spread :D I have just checked it
  8. MrMuppet


    Hi Michael,

    don't get carried away with this. This spread is NOT an arb :D. Don't think you go long DEC at -50$prem and short MAR at -50$prem. DEC decays faster, so tada: risk free profit.

    No, not an arb.

    The problem is that the P/L of those contracts, be it BitMex or Bucketshops are not correlated to the underlying price in a linear fashion.

    As an example if you buy one contract at 50$ and price goes to 100$ you doubled up your money. When you buy the contract at 500$ and price goes up to 550$ you made just 10%.
    With regular futures, you would be making the same, 50$ is 50$ and when ticksize is 10$, you make 5 ticks in one contract and lose 5 in the other. Ratio 1:1

    They are perfect for hedging spot, since they are the reciprocal to a spot position.
    When you own BTC, you are basically long BTC and short USD. If you trade 1/BTCUSD -> long USDBTC against it...perfect hedge.

    But I'm not talking about hedging spot for a lousy cash and carry trade. I'm talking about spreading two contracts against each other. I'm already doing bucketshop quanto's (which are insanely mispriced by the way...if you ever want to be long gamma without time decay...trade these) vs inverse, but now I want to trade inverse vs. inverse.

    The problem is that unlike for example bond convexity, the spread has a break even point were gamma flips. So it's like delta hedging a vertical options spread.
  9. MichalTr


    @MrMuppet I understand that you are talking about spreading those two contracts :) But in this particular example if both Dec18 and Mar19 are priced in USD, both are higly correlated and it's easy to define some hedge ratio for them, so even if there is no fixed tick value - where is the problem in trading those two ? I understand the problem with CFDs or with trading let's say Dec18 BTC (from BitMex) with something else - but where is the issue with Dec18 against Mar19 ? And why it's impossible to make arb on those two ?

    Will be grateful for your answer - maybe those are noob questions but for me it's always nice to learn something, so when I don't understand something I like to ask :D
  10. MrMuppet


    The key to understand here is they are NOT priced in USD!! They are quoted in USD but settled in BTC.

    I don't have any info's that explain the bucketshop trade, you have to do the calc yourself, but the principle is basically the same.

    Have a look at this article, especially the graph at the bottom. http://futuresbit.com/understanding-non-linear-nature-of-inverse-futures/

    As you can see, they're not straight lines (-> not linear), which makes static hedging with the underlying impossible (to stay with your example: you constantly have to adjust the ratio).
    #10     Dec 6, 2018
    MichalTr likes this.