How to Earn Money in a Crab Market
Dear Bankless nation,
Seasoned investors love options because they can be fit to any investment thesis.
They’re commonly used to hedge against volatility or speculate with leveraged exposure.
But one of the golden use-cases is how you can earn profits in a stagnant “crab” market via a delta neutral strategy.
In TradFi, this is pretty much only doable by the most experienced traders that deeply understand these strategies and can actively manage the positions.
DeFi changes this.
We can program these complex strategies into smart contracts and completely automate it, allowing anyone to access the strategy in a click. It just looks like passive income to the end user.
Want to see how you can deploy these strategies to your advantage?
Opyn’s Head of Community Wade Prospere shows us.
- Bankless team
- Crypto-native automated strategies exist for any market condition, including when ETH trades sideways.
- The term "Delta neutral" typically describes a strategy involving a long and a short position, where the combined exposure of the position is market neutral (best for crab 🦀 aka sideways markets)
- Put simply, delta neutral trading is the construction of a position that does not react to small changes in the price of the underlying asset.
- In DeFi, delta neutral strategies can be packaged into structured products, enabling users to earn USD denominated returns in sideways markets with one click.
A lot of traders know how to make money during bullish or bearish markets, but what about sideways markets with little movements?
One benefit of DeFi’s open ecosystem of programmable “money legos” is that crypto-native structured products exist for any market condition, including when ETH trades sideways!
Financial jargon aside, DeFi has enabled automated strategies that allow any trader to earn a return with just one click, even if ETH stays flat. Users deposit in the vault and the contract handles the rest. DeFi traders now have the ability to take part in relatively more involved financial strategies without having to manually put on the trades themselves, which is a common occurrence in traditional finance.
In traditional finance, portfolio strategies that aim to make money in sideways markets are called delta neutral strategies. Delta neutral trading is the construction of a position that does not react to small changes in the price of the underlying asset.
This article first explains delta neutral trading then showcase two different automated delta neutral strategies using options, and end with a manual example and examples of other delta neutral / market neutral DeFi strategies.
What is delta trading?
Delta measures the directional exposure of a position, or the change of an option’s price for a $1 increase in the underlying price.
Delta values range from -1 to +1, with 0 representing a position where the value barely moves relative to price changes in the underlying asset.
Example: Holding ETH has a Delta of 1 since it will gain $1 for every $1 increase in ETH’s price. Conversely, it will lose $1 for every $1 drop in ETH’s price.
Remember, Delta means “change” or “the change” in value.
- Positive Delta: A position with a Delta of 0.5 on ETH will make .5 (half a Dollar) for every $1 increase in ETH’s price. Furthermore, this position would lose .5 (half a Dollar) for every $1 drop in ETH’s price.
- Negative Delta: A position with a Delta of -0.5 on ETH will make .5 (half a Dollar) for a $1 drop in ETH’s price. Furthermore, this position would lose .5 (half a Dollar) for a $1 increase in ETH’s price.
The higher the Delta of a position, the more bullish it is. Vice versa, a low Delta indicates a bearish position. Positions with a Delta of around 0 are termed market neutral, with no significant directional risk.
Delta Neutral: "Delta neutral" usually describes a strategy involving a long and a short position, where the combined delta of the position is at or near zero with no significant directional risk.
The term can involve a number of different strategies, but the concept of delta neutrality (a Delta of around 0) is always the central theme. A delta neutral position evens out the response to market movements for a certain range (up or down) so that the net change of the position is at or close to zero.
For example, if a position has a delta of .03, its value will only change by 3 cents when the underlying asset increases by $1.
For the sake of this article, we’ll talk about delta neutral using options.
Strategy #1: Opyn’s Crab v2
Opyn was the first team to launch an options protocol on Ethereum in early 2020. In January 2022 Opyn and Paradigm announced Squeeth, the first Power Perpetual in existence that gives traders perpetual exposure to ETH².
Squeeth is a DeFi-native derivative that makes options perpetual (no strikes, no expiries).
Long Squeeth is a leveraged position with unlimited ETH² upside, protected downside, and no liquidations. Short Squeeth is a short ETH² position, allowing traders to earn a return (funding rate) paid by long Squeeth holders.
The Crab strategy is an automated strategy that allows users to earn funding (yield) from being short Squeeth.
Since inception, Crab is up 7.73% in USD terms and 35.66% in ETH terms.
Over the same period, ETH is down -20.59%.
High Level Overview
Crab v2 is an automated strategy that earns users USD-denominated returns in sideways markets.
The Crab strategy allows users to earn funding (yield) from being short Squeeth regardless of whether ETH will move up or down. In other words, Crab v2 is a delta neutral strategy.
Remember, delta neutral describes a strategy involving a long and a short position, where the combined exposure of the position is market neutral (best for crab 🦀 aka sideways markets).
A crab position is:
- Long ETH
- Short Squeeth (where the USD denominated returns aka yield is earned!)
At the highest level, the Crab Strategy makes money if ETH moves less than x% up or down between rebalances.
This range is called the profit threshold and it changes based on Squeeth’s funding.
To stay market neutral, the vault rebalances during the crab auction every Monday, Wednesday, Friday around 16:30am UTC (or upon large price movements in ETH).
The main reasons users participate in the crab auction is because the auction typically trades at better prices and users can trade in larger size with less slippage.
Ideal Market Condition for Crab
Crab Strategy is ideal for sideways market conditions (crabs move from side to side, get it?!) when the price of ETH fluctuates within a relatively stable range with periods of low volatility (the price of ETH is calm!).
More specifically, the Crab Strategy does best during periods when Squeeth realized volatility is less than Squeeth implied volatility. Put differently, the strategy takes the view that current implied volatility is too high (markets predict ETH is too high), or that realized volatility will be lower than the market believes. This is a classic “short volatility” position.
So, the ideal market condition to deploy the Crab Strategy is when the price of ETH does not move too much up or down between rebalances.
ETH can move up or down, but it needs to be within a relatively stable daily range (vs being volatile).
Crab Strategy aims to be profitable in USD terms. The USD earned by the strategy is the result of being short an amount of oSQTH. When the price of ETH rises, it tends to sell ETH off, trying to maintain its $ value.
Another benefit of Crab is that it can stack ETH in a bear market. Since it aims to gain value in USD, when ETH goes down it tends to accumulate more ETH. (This is unrealized ETH accumulation. In a bear market you would need to withdraw from the strategy to realize the increased ETH amount.)
In short, when Crab strategy is utilized correctly:
- ETH up = earn USD, reduce ETH
- ETH flat = earn USD
- ETH down = earn USD, stack ETH
How to deposit into Opyn’s Crab Strategy
- Head to https://go.squeeth.com/bankless
- Connect your wallet
- Press the “Approve” button
- Sign the txn.
- Input the amount of ETH you would like to deposit, press the “Deposit” button, sign the transaction, and you’re crabbing!
Additional Resources 📚
Strategy #2: Rysk DHV
Rysk is an on-chain DeFi options protocol. Rysk’s first product is the DHV (Dynamic Hedging Vault), a brand new options AMM, generating uncorrelated returns for its liquidity providers by trading options while targeting delta neutrality.
Rysk DHV enables options trading (vanilla options, strangles, and straddles) effectively acting as an on-chain market maker for options and to some extent an on-chain automated options trading desk.
Given efficient market conditions, the vault will dynamically hedge itself by trading other options, spot or perpetuals to rebalance delta or reduce risk exposure. This mechanism opens opportunities for options arbitrage and cheaper options exposure by automatically adjusting option pricing to incentivize trading options that move the DHV’s portfolio delta back to 0.
Ideal Market Condition for Rysk’s DHV
Rysk’s DHV will have options exposure and is expected to be net short volatility. Although theoretically possible for the vault to be long volatility, this is unlikely due to market participants expected demands.
Being net short volatility, an ideal market for the DHV is one where there is elevated volatility on ETH to harvest. Statistically, realized volatility is lower than implied volatility and is one of the revenue streams for Rysk DHV. The other is picking up spreads from option flow. Liquidity providers benefit from both of these.
Depositors deposit USDC into Rysk DHV and returns are denominated in USDC.
By trading ETH options and targeting delta neutrality, the DHV is able to generate returns in USD terms that are uncorrelated to ETH market movements.
The DHV engages in both long and short options trading but most likely will be short volatility. There are associated risks with this and losses could occur. By collateralizing in USDC and dynamically hedging the vault’s book, the DHV aims to significantly reduce directionality to ETH and maintain a consistent, low-variance daily return for investors.
How to use Rysk
⚠️ Disclaimer: This is brand new technology. Bugs can happen. Please use at your own risk!
Rysk DHV is currently available in its Alpha release. Therefore, it’s only available for users that register for the alpha and want to test out this new strategy.
For those brave enough, you can sign up for the Alpha Club here.
Tell them Bankless sent you!
Strategy #3: Manual Delta Neutral Strategies with Options
Aside from the two automatic DeFi strategies mentioned above, creating delta neutral strategies manually by trading options can enable traders to profit from time decay and volatility.
Though there are many ways to create a delta neutral position using options, let’s take a look at one example:
Remember, a delta-neutral position is one in which the overall delta is zero.
A short straddle consists of one short call and one short put, where the negative delta of the put cancels out the positive delta of the call. Both options have the same underlying asset and the same expiration date. A short straddle profits if the underlying asset trades in a narrow range between the break-even points (similar to the crab strategy!).
This approach minimizes the options’ price movements in relation to the underlying asset.
The maximum profit of a short straddle is limited to the total premiums received less transaction costs. Maximum profit is earned if the short straddle is held to expiration and the price of the underlying doesn’t change. The potential loss is unlimited on the upside (due to being short a the call).
On the downside, potential loss is the strike price -0, because the underlying asset can fall to zero.
While the delta of a short straddle might be 0 when the position is opened, when the price of the underlying increases, the trader must reset the delta of the overall option strategy to 0 by buying a small amount of the underlying. On the other hand, when the price of the underlying decreases, the trader must sell some of the underlying.
Not accounting for transaction costs, if a trader could buy/sell a small amount of the underlying each time it moved they would have a perfect hedge. However, transaction costs prohibit continuous rebalancing in CeFi and even more so on-chain in DeFi.
An Open Design Space
It’s important to note that delta neutral strategies aren’t limited to trading options!
You can implement various delta neutral strategies using other financial instruments that exist in DeFi today.
Below are a few examples of other delta neutral strategies:
- How to deploy delta-neutral liquidity in Uniswap
- Delta neutral strategy using perpetual swaps
- Market neutral strategy using basis trading
Explore the world of delta neutral strategies in DeFi and become a crab master 🦀
- 🧰 Try executing the above options strategies with Opyn v2
- 📖 Read Wade’s previous article on DeFi options strategies
Wade Prospere is the Head of Marketing and Community for Opyn. Prior to joining Opyn, he worked as a Financial Analyst for BofA Merrill Lynch and as a Consultant and Growth Advisor for startups throughout Latin America.