Sortino Ratio

The Sortino Ratio is a variation of the Sharpe Ratio that differentiates harmful volatility from total volatility by using only downside deviation in the denominator. In the context of derivatives and crypto, it is often more useful than the Sharpe Ratio because it does not penalize upside volatility, which is generally desirable for investors.

The ratio is calculated by taking the excess return over a minimum acceptable return and dividing it by the downside deviation. This provides a more accurate picture of risk for strategies that exhibit non-normal return distributions, such as those involving long-gamma options positions.

By focusing on the risk of loss, the Sortino Ratio allows traders to better evaluate the risk-adjusted performance of strategies that may have high variance but limited downside. It is particularly effective for assessing the risk profile of decentralized finance protocols and liquidity provision.

It helps traders focus on protecting capital while still capturing upside potential.