A Beginner's Guide to Cryptocurrency Quantitative Trading: Exploring Hedging Strategies

Welcome back to our journey into cryptocurrency quantitative trading. In our previous session, we designed a simple multi-currency grid strategy. Now, we'll delve into a more complex approach: designing a hedging strategy. Specifically, we will explore a multi-currency calendar spread hedging strategy. If you're familiar with futures trading, you might already know about calendar spreads. For newcomers, don't worry—we'll start with the basics.

Understanding Calendar Spread Hedging

Calendar spread hedging involves taking two opposing positions: going long on one contract and short on another. You then wait to close both positions simultaneously under one of three scenarios:

The long position is profitable, and the short position is losing money, but the gains from the long position exceed the losses from the short position. After offsetting, you net a profit.
The short position is profitable, and the long position is losing money, but the gains from the short position outweigh the losses from the long position. Again, you end up with a net profit.
Both positions are profitable—this is ideal, and you should close them immediately.

In other cases, you might face floating losses, where you either hold the positions or add to them. Since price differences between contracts tend to fluctuate less dramatically than single-asset prices, this strategy carries relatively lower risk—but remember, it's still riskier than it appears.

Theoretical Foundation

Let’s break this down mathematically:

Let A1 be the price of Contract A at Time 1, and B1 be the price of Contract B at Time 1. You short Contract A at A1 and go long on Contract B at B1.
At Time 2, A2 is the price of Contract A, and B2 is the price of Contract B. You close the short position on A at A2 and the long position on B at B2.
The price difference at Time 1 is X = A1 - B1.
The price difference at Time 2 is Y = A2 - B2.
The net profit or loss is X - Y = (A1 - B1) - (A2 - B2) = (A1 - A2) + (B2 - B1).

Here, A1 - A2 represents the profit from closing the short position on A, and B2 - B1 is the profit from closing the long position on B. If the sum is positive, you make a profit. In other words, if X > Y, you gain. Note that this is a theoretical model and doesn't account for transaction costs or slippage.

In cryptocurrency markets, exchanges offer both delivery contracts (with expiration dates) and perpetual contracts (which never expire). Perpetual contracts often track spot prices closely due to funding rate mechanisms. This makes them ideal for pairing with delivery contracts in hedging strategies. Using a longer-term delivery contract reduces the need for frequent rebalancing.

Practical Preparation: Multi-Currency Price Difference Analysis

Before diving into live trading, it's wise to analyze historical price differences. Visualizing data helps identify patterns and opportunities. On platforms like FMZ, charting is straightforward using built-in functions based on Highcharts. The API documentation provides detailed guidance.

Setting Up the Chart

Start by defining which contract pairs you want to analyze. For example, you might focus on perpetual and delivery contracts for major cryptocurrencies:

var arrSwapContractType = ["BTC-USDT-SWAP", "LTC-USDT-SWAP", "ETH-USDT-SWAP", "ETC-USDT-SWAP"]; // Perpetual contracts
var arrDeliveryContractType = ["BTC-USDT-210924", "LTC-USDT-210924", "ETH-USDT-210924", "ETC-USDT-210924"]; // Delivery contracts

Next, create a function to generate chart configurations dynamically based on these arrays:

function createCfg(symbol) {
  var cfg = {
    extension: {
      layout: 'single',
      height: 300,
      col: 6
    },
    title: {
      text: symbol
    },
    xAxis: {
      type: 'datetime'
    },
    series: [{
      name: 'plus',
      data: []
    }]
  };
  return cfg;
}

Fetching Market Data

To get real-time data, use exchange APIs. For instance, OKEx provides aggregated ticker information:

Perpetual contracts: https://www.okex.com/api/v5/market/tickers?instType=SWAP
Delivery contracts: https://www.okex.com/api/v5/market/tickers?instType=FUTURES

Process the data with a helper function:

function getTickers(url) {
  var ret = [];
  try {
    var arr = JSON.parse(HttpQuery(url)).data;
    _.each(arr, function(ele) {
      ret.push({
        bid1: parseFloat(ele.bidPx),
        bid1Vol: parseFloat(ele.bidSz),
        ask1: parseFloat(ele.askPx),
        ask1Vol: parseFloat(ele.askSz),
        symbol: formatSymbol(ele.instId)[0],
        type: "Futures",
        originalSymbol: ele.instId
      });
    });
  } catch (e) {
    return null;
  }
  return ret;
}

Calculating and Displaying Differences

The main loop continuously fetches data, calculates price differences, and updates charts:

function main() {
  var arrCfg = [];
  _.each(arrSwapContractType, function(ct) {
    arrCfg.push(createCfg(formatSymbol(ct)[0]));
  });
  var objCharts = Chart(arrCfg);
  objCharts.reset();

  while (true) {
    var deliveryTickers = getTickers("https://www.okex.com/api/v5/market/tickers?instType=FUTURES");
    var swapTickers = getTickers("https://www.okex.com/api/v5/market/tickers?instType=SWAP");
    if (!deliveryTickers || !swapTickers) {
      Sleep(2000);
      continue;
    }
    // ... further processing and chart updates
    Sleep(interval);
  }
}

This code logs a table showing symbol pairs, delivery/perpetual prices, and positive/negative differentials. Charts update in real-time, helping you spot trends.

Running the Strategy Live

After testing and observing price differences, you can consider implementing the strategy. Always monitor performance and adjust parameters like entry thresholds and position sizes based on market conditions. Remember, backtesting doesn't guarantee future results, so start small and scale cautiously.

👉 Explore advanced hedging tools

Frequently Asked Questions

What is calendar spread hedging?
It involves simultaneously taking long and short positions in related contracts (e.g., different expirations) to profit from price differentials. The goal is to net gains when the spread widens or narrows predictably.

Why use perpetual and delivery contracts together?
Perpetual contracts closely track spot prices due to funding rates, while delivery contracts reflect future expectations. This divergence creates arbitrage opportunities when spreads deviate from historical norms.

How do I manage risk in hedging?
Always factor in transaction costs, slippage, and liquidity. Use stop-losses for individual legs, and avoid overleveraging. Diversify across multiple pairs to reduce idiosyncratic risks.

What tools can help visualize price differences?
Platforms like FMZ offer built-in charting libraries (e.g., Highcharts) for plotting real-time data. APIs from exchanges provide raw ticker information for custom analysis.

Can beginners implement these strategies?
Yes, but start with paper trading or small positions. Understand the math behind spread calculations and practice analyzing historical data before going live.

How often should I rebalance hedged positions?
It depends on market volatility and strategy parameters. Automated scripts can monitor spreads continuously, but avoid overtrading to minimize costs.