Why and when rebalancing to Pseudo-Delta Neutral strategy?

7 min readMar 24, 2022

This post is written by Francium team&community.

When a user creates a PDN position, the initial position does not have any long/short exposure, but as the price changes, the volatile assets in the position and the borrowed volatile assets are inconsistent, resulting in corresponding long/short exposure. If the price goes up or down further, this part of the risk exposure will increase and cause losses. However, the risk exposure can be avoided if the position is rebalanced to a PDN position.

Pros and Cons of Rebalancing

Cons:

Impermanent Loss(IL) is materialized. Rebalancing will cause some losses if the price returns to the initial level, but non-rebalancing will not, and it will bear more losses when the price continues to fluctuate.

Pros:

Avoid long or short position exposure immediately, and if the price of non-stable asset keeps dump or pump, no losses would be generated from such exposures;
No liquidation risk, the maximum loss is limited even in the case of severe price pumping or dumping. See the following Backtesting of case 1and case 2;
When the APR reaches a certain level(60%+), it can still maintain a considerable income even the price decreases by 80+%.

Principles and Scenarios

When the price falls by 1%, the IL for 3x PDN is about 0.015%. When the price decreases by 50%, the IL is 12.87%, but if rebalancing every 1% of the initial price, the cumulative IL in the same dumped price is about 1.125%. The loss is non-linear with the price decrease due to the increase of risk exposure.

“Where rebalancing truly works its wonders is when there is a long term directionality that is strong.” — quoted from @DarkRay in Francium’s Community

How to rebalance

The rebalance operation is essential:

Choose the target leverage ratio, which should be greater than or equal to 2x for PDN strategy.

If the leverage is lower than the target leverage ratio

○ borrow more to achieve the target leverage ratio

○ adjust the percentage of newly borrowed assets so that the newly borrowed NSA is equal to NSA in the “Total Assets in Position Value” — Existing NSA debt value

If the leverage is greater than the target leverage ratio, withdraw and redeposit without leverage to bring it down to the target leverage ratio; borrow more assets if necessary.

Backtesting Data

Backtesting from Francium:

Strategy Description: PDN strategy, 3x leverage ratio, rebalancing when Debt Ratio of the position reaches the rebalancing debt ratio parameter of each model. The long position and short position are tracked separately.

$SOL, 2021.8.1–2022.2.28(7 months)

FarmingAPR: 30%
Lending Interest: USDC 10%; SOL 14%
Principal: $1000

Price Move ($36.25 — $260 — $90)

Case 1 -

Rebalance debt ratio: 68%
Performance: -3.3%

Case 2 -

Rebalance debt ratio: 70%
Performance: Final -1.3%

Without the rebalancing mechanism, the position would be liquidated at around $74. Profit -100%,
Under the rebalancing mechanism, the maximum loss is within 8% at +620% price pump. The maximum debt ratio is 70%.

$SOL, 2021.10.1–2022.2.28(5 months)

FarmingAPR: 30%
Lending Interest: USDC 10%; SOL 14%
Principal: $1000

Price Move ($141.18 — $260 — $90)

Case 3 -

Rebalance debt ratio: 68%
Performance: 4.3%; Almost no loss in this time range.

Case 4 -

Rebalance debt ratio: 70%
Performance: 4.4%; Almost no loss in this time range.

When the price fluctuates between +84% and -36%, the return is positive throughout;
In the case of a 65.4% price drop from the peak, the retracement of position value is around 3%;
Compared with Case 1 and Case 2, it can be seen that the position is easy to maintain a profitable state without a particularly large pump.

$RAY, 2021.10.1–2022.2.28(5 months)

FarmingAPR: 60%
Lending Interest: USDC 10%; RAY 55%
Principal: $1000

Price Move ($9.62 — $12.66 — $2.58)

Case 5 -

Rebalance debt ratio: 68%
Performance: +25.3%; No loss period in this time range.

Case 6 -

Rebalance debt ratio: 70%
Performance: +27.2%; No loss period in this time range.

When the price fluctuates between +31% and -74%, the return is positive throughout;
Under the current APR situation, the backtesting of position value is very small when the price drops sharply;
Compared with the case of $SOL, it can be seen that the profit data increases significantly when the underlying APR increases.

$ORCA, 2021.10.1–2022.2.28(5 months)

FarmingAPR: 60%
Lending Interest: USDC 10%; ORCA 48%
Principal: $1000

Price Move ($16.37 — $18.79 — $2.58)

Case 7 -

Rebalance debt ratio: 68%
Performance: +24.7%; No loss period in this time range.

Case 8 -

Rebalance debt ratio: 70%
Performance: +18.2%; No loss period in this time range.

When the price fluctuates between +14.7% and -85%, the return has almost always been positive;
Under the current APR situation, the backtesting of position value is very small when the price drops sharply;
Compared with the case of $RAY, it can be seen that the price falls further and the position can still maintain profits.

Backtesting from Community:

DarkRay#9557 -

Simulation to backtest and examine the same situation for SOL-USDC from 7 Feb 2022 to 1 Mar 2022. I rebalance when what I term my PDN Imbalance Ratio (article soon) falls outside of my thresholds of -1% to 1% for 12-hour and 24-hour check / compounding.

Rebalancing limits the amount of loss that was suffered during any of the epochs, but that is at the cost of limiting the gains. For this period, since it started, while the equity value did fall below the initial capital at some point without rebalancing, rebalancing kept it above water.

backtesting to 3 months from 01 Dec 2021 to 28 Feb 2022, both did not do so well for SOL-USDC but manages to preserve the original capital when SOL falls 58.86% from $208.70 to $85.86 at the end of the period. But without rebalancing even though it ended slightly higher than rebalancing, there was an epoch where 5.88% of equity value was actually lost while rebalancing tightens that to 0.75%. There was also a time where without rebalancing, 7.40% of the original capital was lost where rebalancing limited it to 0.12%

Where it shines is when dealing with tokens that has a strong directionality in the time frame, such as ORCA-USDC. Here, despite ORCA crashing 80.54% from $12.61 on 01 Dec 2021 to just $2.45 on 28 Feb 2022, the rebalancing kept it above water, while not doing anything caused it to go below water. And similar to the SOL-USDC situation without rebalancing, there was a period where 40.65% of the original capital was lost and an epoch where 11.18% of the equity value was lost. The rebalancing situation never cause any loss to the capital during the time period, with a max epoch loss of 2.98%.

AR#7381 -

some equity loss backtests on SOL/USDT and ATLAS/USD due to rebalancing and get the following results. First I made a table that calculate the realized equity loss based on the number of rebalance and % price change for the rebalance. Then to calculate the number of rebalance, I used a backtester indicator on TradingView which open a new trade immediately after the last TP/SL and set the TP and SL based on the % price change for the rebalance. I subtracted the trade numbers by 1 (which resembles the opening of the PDN position) to get the number of rebalance. The results are not 100% accurate though because the backtester open the new trade 1–2 candles after the last TP/SL instead of opening the new trade on the same candle (there might be other Trading View limitations as well).