Introduction
Cross-period arbitrage in digital currencies is a sophisticated trading strategy that balances risk and reward by simultaneously taking long and short positions across different contract periods. This article recounts my personal experience with a cross-period arbitrage strategy that ended in liquidation—a cautionary tale highlighting the complexities and risks involved.
Understanding Cross-Period Arbitrage
Cross-period arbitrage hinges on the principle of price convergence. Traders exploit price discrepancies between short-term (e.g., weekly) and long-term (e.g., quarterly) futures contracts, expecting the gap to narrow over time. Key components include:
- Two-Legged Trades: Long one contract while shorting another to hedge directional risk.
- Leverage: Magnifies gains but also losses (e.g., 20x leverage amplifies 1% price moves into 10% P/L).
- Grid Trading: A tactical approach to capitalize on price oscillations by scaling in/out of positions as the spread fluctuates.
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The Strategy That Led to Liquidation
Initial Success
In July 2018, the EOS weekly-quarterly contract spread averaged -4.9%. Our strategy involved:
- Shorting Weekly Contracts + Longing Quarterly Contracts
- Grid Execution: Entering positions at 1% spread intervals (e.g., -4.9% → -3.9% = +10% profit at 20x leverage).
Early results were staggering—20% overnight gains during Bitcoin’s spread volatility. The market seemed irrational but profitable, fueling overconfidence.
Critical Flaws
- Account Structure: Opting for multiple sub-accounts (vs. a single account) simplified logic but increased liquidation risk.
- Overleveraging: 20x leverage left no margin for error when spreads diverged unexpectedly.
- Ignoring Warnings: Despite mentor advice, urgency to capitalize on "easy money" overrode risk assessments.
Lessons Learned
- Market Irrationality Outlasts Solvency: Keynes’ adage proved true—spreads widened catastrophically.
- Risk Management > Greed: Leverage amplifies losses as swiftly as gains.
- Single-Account Safety: Unified position sizing prevents fragmented liquidations.
FAQ Section
Q: What’s the biggest risk in cross-period arbitrage?
A: Spread divergence. Even with hedging, extreme volatility can trigger simultaneous margin calls on both legs.
Q: Why avoid multiple sub-accounts?
A: Isolated accounts lack pooled margin, making them prone to individual liquidations during correlated moves.
Q: How much leverage is prudent?
A: 5–10x balances profit potential with survivability. Backtest worst-case scenarios before committing capital.
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Conclusion (Part 1)
This first half dissects the strategy’s mechanics and my early missteps. In Part 2, I’ll detail the liquidation event itself and the hard-won operational changes that followed.