Delta Neutral Strategies & how you can create them

The power of BNBx is now well demonstrated, with ~10 DeFi integrations and multiple trading strategies, users can find the right risk / reward trade-off for their portfolio.

We have also talked extensively about some of the risks associated with these trading strategies, one of which is the Price Risk associated with the price movement of the tokens involved in the strategy. This price risk often goes under the radar and leaves the user open to losses arising from adverse market movements, delta-neutral strategies aim to eliminate this risk.

Understanding Delta

“Delta” or “Delta Risk” is a term often used in the Trad-Fi world to describe the sensitivity of a derivative or a portfolio (or any investment) to the price movement in an underlying asset. For example, if you buy a forward contract for a stock , you have Delta risk on your position owing to the change in price of the underlying stock

Delta — Neutral strategy Objectives

The objective of Delta-Neutral strategies is to eliminate the Delta risk, so that value of the portfolio/ yield of the strategy remains the same no matter the price movement in the underlying token. By the nature of this objective, the profit from deploying delta-neutral strategies arises from the yield generated by the strategy ( because a rise in prices of the underlying token does not lead to profit)

Components of a Delta-Neutral strategy

Delta-neutral strategies can be created in many ways, some of which are complex and contain many components. Conceptually we can think of the components of a delta-neutral strategy in 2 broad buckets

1. Yield leg: This is the part of the strategy which generates yield on an underlying token or asset. However, this leg also creates exposure to the underlying asset and hence price. Delta risk on the underlying asset, A simple yield leg could be thought of as staking BNB with Stader to mint the yield bearing token BNBx.
2. Hedge: This part of the delta-neutral strategy ensures that there is a counterbalance to the delta risk created by the yield leg so that the price movement in the underlying asset do not affect the outcome of the strategy. In our example, taking a short position in a BNB futures contract , will lock in the price of BNB that will be generated by the yield leg, thereby making the overall strategy delta neutral with respect to the price of the BNB token

Risks in Delta Neutral strategies

While delta-neutral strategies aim to remove the price risk in the underlying token there are still some risks associated with them. Chief amongst which is the smart contract risk related to the various protocols used to execute this strategy. Additionally, in complex strategies that use borrowing / leverage a temporary movement in price can cause liquidation and hence cause the delta-neutral strategy to breakdown