November 28, 2022
One of the longstanding realities of crypto is much higher levels of volatility than what's typically found in traditional markets. Instead of being relatively rare events, significant spikes or decreases in price are a regular occurrence for cryptocurrencies. While elevated volatility may cause long-term investors to lose hair from the stress, it offers tremendous opportunities for savvy traders to make significant profits. And one tool to capitalize on these opportunities is crypto options.
Volatility Metrics for Crypto Options
Crypto options work similarly to traditional options, which means the value can fluctuate significantly based on several factors. In the context of volatility, two metrics matter for evaluating option prices and profit potential: implied volatility and realized volatility.
Implied volatility forecasts how much the market is likely to move, while realized volatility is how much the market actually moves. Comparing the two provides an idea of whether an option is cheap or expensive.
"For example, how volatile are days that are up days versus how volatile are days that are down days," asks Greg Magadini, Amberdata's Director of Derivatives. "Or another way to look at it is if I look at the past ten years of Bitcoin prices, what has been the maximum realized volatility we've seen for a 30-day period and what's been the minimum? And where are we right now in relation to that? Are we around the median, or are we in the upper 90th percentile?
"So, now that I have those two pieces, I can say implied volatility versus realized volatility is either cheap or expensive. And then, within the implied volatility realm, these strikes are cheap or expensive versus these strikes. And all of a sudden, I can construct a really efficient portfolio of options instruments."
Don't Overlook Vega
Additionally, when looking at a particular option and weighing the potential impact of volatility, it's important to look at the option's Vega. This value is one of the options "greeks." It indicates how sensitive the option's price is to changes in the underlying asset's volatility. The higher the Vega, the more the price of the option will move with an increase or decrease in volatility. That said, the variation of changes in implied volatility, which Vega prices to dollars, differs between expirations. Weighting everything together is another important component.
How Volatility Can Be Used to Determine a Trade
While realized volatility does not affect option prices directly, implied volatility is a direct component of the price. As a result, traders generally look to buy options when implied volatility is low and sell them when implied volatility is high.
For example, if you have an investment strategy that's long BTC, you may choose to take a short position as a hedge after a significant run-up (or to capitalize on an expected short-term price drop). Various strategies can be employed, but the simplest would be either buying puts or selling covered calls.
Both strategies are bets that the price of BTC will go down in the short to medium term, depending on the expiration date of the options you're exploring. If implied volatility is low and realized volatility trends indicate a spike in volatility is likely, buying a put will likely be the better strategy. If the price of BTC drops sharply, the option's implied volatility will increase significantly, driving a significant price increase.
Conversely, if implied volatility is high and realized volatility trends indicate a drop in volatility is likely, selling covered calls could be more profitable. The option's price will go down along with volatility, resulting in a profitable trade when the option is purchased to close the position. This strategy works better than buying puts if the price of BTC is expected to trend sideways or decline slowly instead of rapidly.
For more advanced options strategies, gauging volatility becomes even more important.
How to Get Volatility Data
To evaluate crypto option prices, you need data. With AD Derivatives, you get comprehensive data for option prices, greeks, implied volatility, realized volatility, and more for BTC and ETH options on major crypto option platforms, including Deribit, Bybit, and Bit.com.
The AD Derivatives platform also includes a robust suite of tools that allow traders to identify opportunities, manage risk, and build options strategies.
Want to learn more about how you can capitalize on crypto's volatility with crypto options? Explore the AD Derivatives platform for free today or contact us to gain access to the Pro version.
Disclaimer: Not trading advice. This article is for educational purposes only.
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