Chapter 8 - Hedge IL in CLAMM
Overview
Remember from Chapter 3 that providing liquidity in a full range AMM is like selling a perpetual option straddle. Due to the one sided rebalancing and higher leverage, providing liquidity in a Concentrated Liquidity AMM is like selling a covered call or put option.
Compare the above short call option exposure with an LP position in UniV3 ETH/USDC pool at +-15% range below. You can see it looks exactly like a short call option exposure.
Therefore, to hedge the Impermanent Loss in a CLAMM we must combine the LP position with a ETH long position in the corresponding pool (ETH/USDC). This will neutralize the short call exposure with long perpetual option exposure in GammaSwap. As you can see from the below graphic, the IL is perfectly hedged within range providing delta neutral exposure in ETH terms.
If the position goes out of range, the LP position will no longer earn yield and you will be paying to hold the GammaSwap long position. Pairing the same LP position with a short in GammaSwap would lead to delta neutral exposure in USDC terms.
To calculate the hedge, use the following spreadsheet. We will walk through how to use it below.
TL;DR
CL position in ETH/USDC + ETH/USDC Long = Delta neutral ETH exposure
CL position in ETH/USDC + ETH/USDC Short = Delta Neutral USDC exposure. You can use the CL IL Hedge spreadsheet, same exact values just open a short instead of a long to get USDC exposure.
This spreadsheet also works with any pool just make sure you are entering the right price.
Calculate Values
Let's provide liquidity into a +-30% LP position on the 5 bps ETH/USDC pool on Base network in Uniswap V3. We recommend when starting a hedge strategy to start wide and narrow it over time as you get used to the strategy.
Get the LP Yield
To find the yield for providing liquidity in the +-30% range on Uniswap V3, we can use DeFi Llama. These APYs are quoted in this range.
For the top WETH/USDC (0.05%) pool with 19.68M in TVL, we can see the yield is 102%.
Get borrow APR from GammaSwap
Now we will get the borrow APR from the corresponding WETH/USDC pool on GammaSwap Base deployment.
We can see the borrow APR is 4.61% for WETH/USDC. We can also click on the Utilization tab and Borrow APR tab to see historical variance.
Input values in spreadsheet
Now it is time to input the values into the spreadsheet.
Enter the values in the highlighted orange input boxes above. Price - Current price of ETH
GS Borrow APR - The borrow APR from the ETH/USDC pool on GammaSwap
Exit Price - For simplicity make it the current price now. Once we create the position, we can play around with this value to see how the Net APY changes.
Days Open - How long you plan on holding the position. Choose a conservative value here to accompany a wide range.
LP Deposit Amt (ETH) - How much you plan to deposit into the LP position in ETH terms. 1 ETH would be a $2,979 total LP position.
LP Lower Price - The lower ETH price for the range. It is a +-30% range so to calculate the lower price we will multiply .7 * 2979 = 2,085
LP Upper Price - The upper ETH price for the range. It is a +-30% range so to calculate the upper price we will multiply 1.3 * 2979 = 3,872
Enter Positions
Once we have entered the values into the spreadsheet, we now have the information we need to begin entering positions.
To enter our ETH long position on GammaSwap. we need the deposit USDC value, the Loan Amt (USDC) and the LTV.
We select "Long" in the corresponding ETH/USDC pool on GammaSwap trade page, enter in the Deposit USDC value of 494.58, increase the leverage on the slider until the LTV and Loan AMT USDC match as closely as possible to the spreadsheet.
Be aware there are two main risks here on the hedge. There are no price based liquidations but there is a time to liquidation of 63 days (depends on the borrow rate). This rate can increase if the borrow rate increases. If the borrow rate increases substantially, hedging might no longer be profitable.
Uniswap V3 LP Position
Now we will add the appropriate ETH and USDC amounts from the spreadsheet into the UniV3 ETH/USDC 5 BPS pool on Base.
Now we need to deposit .4292 ETH with 1,700 USDC into the range 2,085 to 3,872.
We match the price range and the deposit amount. Note the USDC value is a bit short of what we got in the spreadsheet. This is because the price changed as I was writing this Chapter. You should be able to execute faster than me ;)
Hedged Position
Now we are done and we have delta neutral exposure to ETH!
Note: The above graphic is depicting your annualized APY not your principal!
If the position goes out of range, you can exit your positions and re-enter based on the new price. It is recommended to do this as you approach the end of the range to minimize losses, however. Remember, the trade doesn't work if you go out of range since you will stop earning yield from your LP position!
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