Revisiting the Fundamentals of Pseudo-Delta Neutral Hedging

After my first Pseudo-Delta Neutral Hedging (PDN) article, I had received feedback from some readers that my explanation of achieving the PDN state through the balancing of the non-stable asset in LP position and debt differs from some other explanations that they had heard or learned about, where the 2 positions that have been set up will balance out each other, and they are somewhat confused by the 2 different approaches.

Disclaimer: This is not investment or financial advice, but a sharing of my adventures and learnings in crypto space, where I conduct various experiments with different tokens and protocols across different blockchains.

Well, they are actually the same, just that we are breaking down the positions in different ways. Let me explain by recapping the example I gave of setting up a PDN position by relying on 3x LYF for ETH-USDC farms:

1. Set up 3x LYF with US$100 of USDC, borrowing USDC. The net position value is 3x of the initial capital or US$300. US$200 worth of USDC will be borrowed (that is the leverage) and of this initial US$300 of USDC, half of it will be converted to ETH. This means for this trade, it will be long US$150 of ETH + US$150 of USDC in the LP and short US$200 of USDC as debt.
2. Set up 3x LYF with US$300 of USDC, borrowing ETH. The net position value is 3x of the initial capital or US$900. US$600 worth of ETH will be borrowed and of this initial US$300 of USDC + US$600 of ETH, US$150 of ETH will be converted to USDC. This means for this trade, one will be long US$450 of ETH + US$450 of USDC in the LP and short US$600 of ETH as debt.

Setting up a PDN Position using 3x LYF

I then explained that for ETH, because we have exactly US$600 worth of it in both long (amount in LP) and short (amount in debt) positions, they cancel each other out (US$600 — US$600 = US$0 worth of ETH) and thus insulate the overall combined position from ETH’s price movements.

Now, let us look at this in a different way by focusing on the net amount of ETH itself in the 2 positions instead,

1. Position 1 has US$150 of ETH in the LP and US$0 of debt in ETH. So the net position is US$150 - US$0 = US$150 long in ETH.
2. Position 2 has US$450 of ETH in the LP and US$600 of debt in ETH. So the…