Mean Reversion Strategy in Crypto Rate Trading
In the world of on-chain interest rate trading, traders are always looking for new strategies to capitalize on market inefficiencies.
This article highlights a technique that leverages the mean-reverting nature of funding rate spreads across different exchanges, focusing on a specific trade setup using the Rho Protocol, which aims to profit from the potential convergence of the Binance and OKX Bitcoin funding rates.
Understanding the spread: Analyzing funding rate behaviors
Historically, the spread between Binance and OKX Bitcoin funding rates has shown a tendency to revert to the mean. In the last year, this spread has generally stayed positive, around 2%, but there have been peaks where it widened to over 5%. At times, this spread has also dipped into the negative territory.
* Spreads are obtained using a 7-day moving average. The rates are annualized (APR).
Sources: Binance and OKX.
Constructing the trade: Setting up strategic positions
To take advantage of the current market conditions, where the spread is inverted, we can construct a trade using two futures contracts on Rho Protocol. The aim is to bet on the spread reverting to its usual mean, with Binance's funding rate rising above OKX's. Our approach includes taking a long position on Binance BTC funding and a short on OKX BTC funding, betting on their rates diverging to reverse the spread.
Trade execution: How we set up on Rho Protocol
To execute this trade, we connected a new pre-funded wallet on Rho Protocol and deposited 1,000 USDT worth of collateral, split equally between the Binance and OKX BTC USDT funding markets. In this example, the date of trading is 06-June-2024.
We then placed two trades:
1. Long position on Binance BTC USDT funding futures expiring on 28-June-2024, with a notional value of $50,000, using 100x leverage.
2. Short position on OKX BTC USDT funding futures expiring on 28-June-2024, with a notional value of $50,000, using 100x leverage.
The entry price (rate) of the long position is 13%.
The entry price (rate) of the short position is 16%.
Therefore, the trade starts at a Binance / OKX spread of -3%.
Risk management
Despite the high leverage used in this trade, the estimated liquidation rates provide a comfortable buffer. For the Binance position, liquidation would occur only if the fixed rate drops to around 2.0% APR.
Similarly, for the OKX position, liquidation would happen if the fixed rate rises to 26% APR. These liquidation levels are based on the expectation of average rates from the trade date until the maturity date, that is 22 days, making them relatively safe bets.
Moreover, since the Binance and OKX funding rates are highly correlated, the long and short positions provide a quasi-market-neutral bet, hedging against directional moves to some extent. In other words, while the position in one market loses money with market moves, the other position offsets with profits.
Example of a successful outcome if spread reverts
Starting Conditions
- Spread at Start: The trade begins with a -3% spread, where Binance’s rate is 13% and OKX’s rate is 16%.
Rate Changes by Maturity
- Binance’s Rate: Increases from 13% to 14%.
- OKX’s Rate: Decreases from 16% to 13%.
Results
- Binance's Long Position: Earns a profit of 1% because the rate increased by 1% from the initial rate.
- OKX's Short Position: Earns a profit of 3% because the rate decreased by 3% from the initial rate.
Spread Change
- The spread changes from -3% to +4%, a total movement of 7 percentage points.
Profit Calculation
- Contract Value: $50,000 with 100x leverage.
- Profit on Spread Shift: $210 from a 7% spread change.
- Total Return on Deposit: 21% increase over the original $1,000 deposit in 22 days, excluding transaction fees.
Conclusion
The success of this particular strategy hinges on spotting and betting on opportunities where the spread has deviated from, and one predicts it will return to its historical average.
Although the trade uses substantial leverage, the liquidation points and correlated nature of the funding rates offer some layers of risk management.
As the strategy unfolds, it will be intriguing to see its performance and its effectiveness at tapping into these market inefficiencies.
Ready to explore the potential of mean reversion in crypto rate trading? Try the Rho Protocol today and start capitalizing on funding rate spreads between Binance and OKX.
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