Hedging a spot position with a short perp

If you hold two units of an asset and short two units of the perp on the same asset, your net exposure is zero. A ten percent fall costs you nothing and a ten percent rally earns you nothing, because the two legs cancel. That is the point and also the whole cost. People sometimes place a hedge hoping it behaves like a stop, and are then unhappy in the rally that follows. A hedge is a freeze, and freezes are a decision about a period of time rather than about a price level.

Say you hold two ETH and the price is four thousand, so eight thousand dollars of exposure. A full hedge is a short of two ETH on the perp, which is eight thousand of notional and at five times leverage requires one thousand six hundred dollars of margin. A half hedge is a short of one ETH: you keep half the upside and half the downside, and you have halved the margin needed. Partial hedges are underused, and they are usually the honest expression of a view that is uncertain rather than absent.

The carry on the hedge is funding plus fees. On an eight thousand dollar short with funding at one basis point every eight hours in your favour, the position is credited about two dollars forty a day, which pays you to hold the hedge. If funding turns negative the same position costs you that amount instead. Add the fee on opening the short and the fee on closing it, and you have the total cost of standing still for the length of the hedge.

If there is no perp on what you hold, a correlated instrument can stand in: a basket of alts hedged with a BTC short, an equity position hedged with an index perp. The residual is the difference in behaviour between the two, and that residual becomes the position you are actually running. In a broad selloff correlations move toward one and the hedge works. In a rotation, the thing you hold falls while the thing you shorted rallies, and you lose on both legs at once.

The failures are operational far more often than they are analytical.

• The short is liquidated in a rally while the spot gain sits unrealised somewhere else, leaving you unhedged at the worst moment
• The hedge is left on after the reason for it has passed, quietly costing carry
• Over-hedging turns a neutral position into a net short without anyone deciding to
• Basis moves: perp and spot do not track perfectly, and the gap is a small live position of its own
• Realising a loss on one leg can have consequences the unrealised gain on the other does not offset, and this varies by jurisdiction

A hedge earns its complexity when selling is not available or not desirable: a locked or vesting allocation, an asset you want to keep holding for reasons other than price, a defined event you want to sit out, or a transfer that would take longer than the risk window. If you can simply sell and buy back, selling is cheaper, simpler and has no liquidation risk. Reach for the hedge when the constraint is real.