How to Hedge Impermanent Loss
Impermanent loss (IL) erodes LP profits when token prices diverge. Hedging strategies can reduce or eliminate this risk.
Understanding IL
IL occurs because AMMs rebalance your position as prices move. The more prices diverge, the more IL you suffer.
IL by Price Change:| Price Change | IL |
|---|---|
| . . . . . . . | . . - |
| 1.25x / 0.8x | 0.6% |
| 1.5x / 0.67x | 2.0% |
| 2x / 0.5x | 5.7% |
| 5x / 0.2x | 25.5% |
Hedging Methods
| Method | Complexity | Cost | Coverage |
|---|---|---|---|
| . . . . | . . . . . . | . . . | . . . . . |
| Perp hedge | Medium | Funding | Partial |
| Options | High | Premium | Full |
| Single-sided LP | Low | Reduced yield | Reduced |
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Step-by-Step Instructions
Calculate IL Exposure
Determine your LP position composition and potential IL at various price points.
Tips
- ✓Use IL calculator tools
- ✓Map exposure to both tokens
- ✓Concentrated LP has more IL risk
Choose Hedging Method
Perps are most accessible. Options provide best protection. Single-sided reduces but does not eliminate.
Tips
- ✓Perps: easy but ongoing costs
- ✓Options: defined cost, full protection
- ✓Match hedge to exposure
Size Your Hedge
Calculate hedge size to offset IL exposure. Usually hedge the volatile token.
Tips
- ✓Hedge delta, not full position
- ✓Partial hedge reduces cost
- ✓Model various scenarios
Execute Hedge
Open perp short or buy options. Match notional to LP exposure.
Tips
- ✓Use low leverage on perps
- ✓Options premium is max loss
- ✓Document hedge ratio
Monitor Correlation
Hedge effectiveness depends on price correlation. Rebalance if needed.
Tips
- ✓LP value changes with price
- ✓Adjust hedge as position changes
- ✓Track net P&L
Manage Hedge Costs
Perp funding and options premiums eat into yield. Balance protection vs cost.
Tips
- ✓Negative funding = you pay
- ✓Options decay over time
- ✓Compare cost to LP yield
Evaluate Strategy
Compare hedged returns to unhedged. Decide if protection is worth the cost.
Tips
- ✓Hedging is not always profitable
- ✓Best in high volatility
- ✓Adjust based on results