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EducationalOctober 12, 2021

Systematic Risks - What Are They, And How To Mitigate Using Crypto Futures and Options

Shubham Goyal
Product Specialist
October 12, 2021

We live in a world of uncertainty, and Investing in cryptocurrencies has its own risks and returns. But, learning about the different risks at play can help you succeed in investing in the crypto market. Our primary focus will be on systematic risks as they are risks correlated with the entire market segment and are unavoidable. Thus, there is a broader need for mitigating and strategizing against systematic risks by using crypto futures and options.

Systematic risks and their types

Systematic risks go by many different names, such as market risk, non-diversifiable, or volatility risk. We can define them as risks that are uncontrollable and impossible to avoid as they are unpredictable in nature.

The impact of systematic risk is on the entire market rather than a specific company or individual. You have the option of mitigating this risk to some extent by diversifying your portfolio. However, your portfolio will still be at risk as systematic risk is impossible to avoid completely. To better understand systematic risk, we can take the example of inflation and interest rate changes that affect the entire market. Other examples of systematic risks are natural disasters, political instability, currency value changes, etc.

There are different types of systematic risk that can affect your portfolio, and they are as follows:

  1. Market risk- Market risk occurs when the investors move along with the market as they follow the market’s current direction, which causes the prices of cryptocurrencies to all move together. For example, if the market is dropping, the investors follow the same herding pattern, causing even the promising performing cryptocurrencies to fall.

  2. Interest rate risk- Interest rate risk occurs when there are changes in the interest rate from time to time. This type of risk affects debt securities and bonds as they have fixed rates of interest. Interest rate risk has the following classifications:

    – Price risk
    – This type of risk may arise when there is a possibility that the investment will fail or decline in the future.
    – Reinvestment rate risk– This risk occurs due to the fact that you cannot reinvest the interest or the dividend you were earning from an investment with the same rate of return as you were acquiring earlier.

  3. Exchange rate risk– This type of risk occurs only for other exchange transactions and investments. The rates keep fluctuating, and there is always some uncertainty while dealing with a particular exchange versus another.

  4. Purchasing power risk- This is a type of systematic risk, which also goes by the name inflation risk as it occurs due to inflation. So, this type of risk affects the purchasing power. During inflation, there is a decrease in the value of money due to the increase in the prices of investments, which reduces the purchasing power of individuals.

How to mitigate against systematic risk using Crypto futures and options

One way to mitigate against systematic risk is by using crypto futures and options. Here is how crypto futures and options work and helps you minimize the systematic risk.

Crypto Futures and how it can mitigate systematic risks

With the help of cryptocurrency futures, you can maximize your returns by speculating the market’s direction and minimizing the systematic risk. Futures are derivative contracts which is an agreement for buying or selling an asset at a later date for the fixed price. Few benefits of using crypto futures for mitigating the systematic risk are as follows:

  1. Hedging- Crypto futures gives you an opportunity to manage systematic risks by locking in a fixed price to get a layer of protection against fluctuations in the market prices. Hedging can allow you to safeguard your investments by fixing a price even when the market price of cryptocurrencies fluctuates.
  2. Maximize profits during price fluctuations– You can easily make profits during changes in the prices of cryptocurrency. For instance, you can benefit from a price drop in BTC by using short selling in Bitcoin futures trading.
  3. Margin trading and leveraging– Crypto futures trading allows you to make high profits with a small initial investment. It is because the leverage is high, and you have the option of opening and closing the market positions with a fraction of your personal balance.

Crypto options and how they can mitigate systematic risks

Crypto options are derivative contracts that are similar to crypto futures, with the exception where traders have the right but not the obligation to buy or sell the underlying crypto asset at a set price. There are two kinds of options: call option and put option. The right to buy the underlying crypto asset is the call option, and the right to sell is the put option. Here are a few benefits of using crypto futures to mitigate systemic risks:

  1. With the help of crypto options trading, you have the option (pun intended!) of employing both leveraging and margin trading strategies and get all the usual benefits of crypto futures trading.
  2. The best investments that you can opt for during high price fluctuations with an uncertainty of price swings in either direction are move options. You can make profits from market volatility without the need to predict the direction of price movements.

Conclusion

You can mitigate systematic risk in crypto trading by using crypto futures and options. You can visit the official website of Delta to learn more about trading crypto derivatives.

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