This is an extract from June Monthly Digest

This section is written by CMS Holding

In the eternal war in finance of the machines versus mankind CMS finds itself firmly planted fighting in the corner of organic matter. This means our approach to EV and risk will be a little more nebulous than more systematic or TA based traders who have more defined open and closing levels of where they feel risk is best warehoused and shed. So how does this work in practice?

Our world exists as two distinct pools of assets. Actionable and unactionable. Actionable risk is positions that are liquid and can be acted on, long BCH, short ZEC, balls long BBQcoin this is the bulk of the tradeable universe and takes up ~75% of our risk capacity at any given time. Unactionable positions for some reason or another are not liquid or able to be transacted, think startup equity or unvested tokens, these make up the remaining risk capital usage of the desk.

Every unactionable position is considered in its net notional exposure context, how much $ is at risk, and we rarely hedge any of this overall exposure with other assets. Meaning if we are long some token from an investment we are wearing that risk till liquidity and not trying to offset it in the liquid markets by selling other assets against it. We structure all decisions around it with this in mind.

So what do we consider beyond the outright merits of illiquid positions we plan to take? The biggest and by far most important is time to liquidity. To understand why this is so important you need some risk free rate at time of transaction for comparison. Nothing in crypto is risk free but we like to use our benchmark return rate, the implied cash lending rate from the futures rolldown, buy spot sell futures. This means when the curve is steeply contango a deal has to be exceptionally interesting to us to warrant shifting the balance sheet over to it for the time being.

Every actionable position long or short is considered in the context of the overall exposure of the main book’s net BTC exposure with some target we have for that with additional context for net notional exposure. The main book is the amalgamation of every and any trade we have in flight all mashed into one big high level view of risk. So to recap we keep some target at all times of what we want overall risk to be in BTC terms and have hard caps on notional exposure as well.

The reason you need notional risk limits and a BTC exposure to be different has to do with how we calculate that BTC exposure number. Every asset gets assigned a beta, much like you would in equities to say the S&P we do for all crypto to BTC. The beta just defines what the expected move in the asset is per move in BTC, so an asset is beta 2.0 if bitcoin goes you’d expect a 2x move in that asset. Now betas are time dependent so this brings up the issue of how much history to use, we prefer a short window usually around a month since you get regime shifts in narratives and they can move quite quickly, like suddenly defi is hot or something, so you want to have a shorter history tail. So assets with low beta such as LEO you can really put on a lot of notional before you move the overall BTC risk. Also, there’s risk you’ll find yourself 3x levered in USD terms but look 1x levered in BTC terms and that’s dangerous.

So does this mean as long as you stay in the global risk params you can just gun the whole book max long BSV? No, individual risk sizes are done on the fly usually it’s as simple as X is happening or dislocated bringing Y to some notional exposure all just tossed quickly over chat. If that trade brings us outside of our target you need to find something else to sell / buy against it to keep us in line, sometimes that’s BTC, sometimes it’s ALT, sometimes it’s TRUMP futures, we don’t really do that.

End of the day you have one big risk soup of names you like, names you may be apathetic to that you just need to have in there to offset beta and names you hate. There’s a million reasons why you like or dislike any of those names over some time frame, but it’s irrelevant to the overall structuring of the risk.

But wait there’s more, remember the financing considerations for illiquid positions don’t just disappear for liquid names, you still need to think you’ll clear that hurdle, but much more importantly you need to think about the implied financing of the positions you’re putting on. So if you’re buying spot you’re burning cash so you’re beholden to the same rules of the illiquid positions and same hurdle rate, if you’re using futures you need to think perp or defined financing meaning are you going to use a variable funding mechanism or a durational future and then what does that financing look like. Depending on direction and contango / backwardation you may not only be missing out on collecting financing, but you may be paying it and for perps you’re in an undefined future financing. In general, we like to structure our futures positions to net pay us, unless we think the basis is itself too cheap, but it’s another parameter that has to be considered. You also need to be thinking about your overall basis risk of your portfolio at any time, especially since basis itself trades with beta to the overall market.

It seems like a lot of different params, but like any good system you get in a groove and eventually it allows you to concentrate on finding an edge in the market and then the motions become memory about which buttons to mash.