It combines a long position in the spot market and a short position in futures when the market is in contango – a condition where the future prices of an underlying asset are higher than the current spot price.
Carry traders make money irrespective of the market trend, although the return depends on how steep is the contango.
The situation was more pronounced during the height of the bull run in mid-April when bitcoin hit a record high above $64,800, lifting the premium on June futures to 25% on the Chicago Mercantile Exchange .
Several trading firms employed carry strategies back then, as reported by CoinDesk, and may have squared off positions early after the mid-May crash.
In the second half of April, the annualized cost of borrowing tether on the decentralized finance protocol Compound was around 8%.
In finance, convexity refers to non-linearity, meaning that if the price of the underlying asset changes, the resulting change in the cost of the derivative is non-linear.
For example, assume a certain stock is currently trading at $100, and a trader owns a $120 call expiring in September.
“Those tail options were cheap, in our opinion, when bitcoin first broke through $20,000,” said Tang.
While LedgerPrime switched the strategy in the second quarter, some traders continued to pile into cheap call options at $80,000 in hopes for a continued bull run.
Overall, the derivative market has cooled in the wake of the price crash, as excess bullish leverage has exited the market.
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