May 17, 2021

BTC Funding Rate Turns Sharply Negative

As of this morning following the market selloff BTC-perpetual funding rate, aka basis, turned sharpy negative after trading in green for the last 1/2 year. From the chart below it looks like breaking 44K level triggered the decline, and this can signify a major shift in investor sentiment. This can also possibly be an end to both general crypto bull market, and also dampen DeFi projects since their performance correlates to volatility and funding rates. 




Apr 11, 2021

Cryptocurrency Volatility Indexes

 Last week I wrote about BVOL - bitcoin volatility index launch on Deribit. However this is not the first crypto volatility index. In fact last year T3 Indexes - the folks behind SPIKES volatility index launched both Bitcoin and Etherium volatility indexes, and already executed trades tied to their BitVol index on LedgerX platform. 

The first trade executed about a month ago was a call spread; the second one traded last week for a pension plan, and established a long Bitvol position via a short put spread and calls. 

As typical with new financial instruments, futures on BitVol will likely to be listed first. What their pricing may look like? We can take a clue from existing volatility indexes - where pricing is based more on the statistical properties of the process rather than no-arbitrage principles. So, let's take a look :

The chart above is the full available history of the index; median is 79 and mean is 85 - just a tad higher than the current value of 82. We see large spikes when Bitcoin rose and fell - implying both put and call skews.
 
 
 
 Similar to the VIX, the distribution of values is right-skewed, and log transformation makes the distribution almost normal. With the volatility of volatility of  ~ 120 it is not that much higher than that of the VIX. Trying to model the index as a simple Ornstein-Uhlenbeck (mean-reversion) process in log was kind of mess - the data is very noisy.


Eventually I was able to estimate reasonable parameters, and came up with the following short-term curve ( assuming current value of 82 ) for the next 28 days. Practically I assume that there will be monthly expirations to coincide with the monthly options expiration cycle.

 

In the following posts I will continue writing more about these exciting products. In the meantime, if you are an active options trader and are interested in trading Bitcoin or Ether derivatives take a look at Deribit which is the leading crypto derivatives exchange with 90% of market share. And if you have any questions about the post, feel free to reach out to my email address on the sidebar.

Mar 31, 2021

DVOL – Deribit Implied Volatility Index

DVOL volatility index


 If you woke up this morning and realized that Deribit page looks somewhat different, you're correct: today the largest crypto-derivatives exchange premiered its own real-time volatility index. The methodology is variance swap with standard liquidity adjustments. Since Deribit trades north of 90% of cryptocurrency options this is a significant and important market benchmark.

Exchange's plans are ambitions:  they are planning on launching futures on volatility index "very soon." In upcoming posts I hope to cover some mathematics behind volatility index, and how futures on DVOL can be priced. 

Read more details here. As I mentioned in previous posts - if you want to trade Bitcoin and Ether options there is no better, more liquid and more robust place than Deribit. With recent market run-up there are ample opportunities to capitalize on skew in cryptocurrency options.



Mar 29, 2021

The Early History of Volatility Indexes

 

CBOE - history of volatility
When CBOE started trading options in 1973, only calls on individual stock options were listed. Puts followed few months later, but it took until 1983 - another decade until index options were introduced. The leading index at that time was the S&P 100 index - partially because of limited computing power, and easier replication than the broader S&P 500, and S&P 100 options were the most popular index options. 

When the stock market crashed in October of 1987, Robert Whaley was low level finance teacher at Duke and moonlighting as consultant in finance-related lawsuits, including one for CBOE. The exchange was being sued for mishandling operations during the crash and letting options trade at unreasonable prices, and during one of the discussions he proposed that “... it would really be interesting to have an index on volatility.” A volatility index was proposed earlier in an academic paper by Menachem Brenner and Dan Galai, but it was more of a theoretical idea - they wrote that a volatility index can be based either on realized volatility, or implied, and provided no practical details. It fell of Whaley to solve all the issues with implementing a practical and useful volatility index.

In 1992 Whaley spent 4 months on a mini-sabbatical in France with a pile of a hard-drives with options data from CBOE working on volatility index. He writes:

The trouble you have by focusing in on the implied volatility of a single option is that its maturity changes every day. And its relationship with the underlying index level changes every day as it moves around the exercise price of the option. So the key ingredients to developing a sensible index would be to somehow hold the moneyness constant—make it an at-the-money option by interpolating around the index level. And by using options with different maturities, interpolate to get a constant 30 days to maturity.
In January of 1993 CBOE introduced VIX - a volatility index on S&P 100, and started disseminating it in real-time. As the concept of implied volatility, or expected variance is too much for talking-heads VIX caught on the moniker "the fear index"; the values of the index became some sort of a sentiment measure, an indicator how nervous investors are about stock decline. This turns out to be quite correct - while stock implied volatility is an unbiased predictor of future realized volatility, index volatility typically runs at a premium, mostly driven by put buying. 

In the following decade options trading has expanded tremendously, and index options became a major revenue source for CBOE. In 2003 they started thinking about launching VIX derivatives, and revamped VIX index using "model free" methodology: instead of using the Black-Scholes formula, the new VIX was calculated as square root of weighted sum of all options. I have blogged about this change, and intuitive meaning behind it.  The underlying options complex for the new VIX was changed to now more liquid S&P 500 options, and the old index was renamed VXO.

Now Whaley is highly acclaimed for his contributions to volatility, and works as a professor at Vanderbilt. 

I follow that number each and every day. I mean, it’s as meaningful to me as looking at the level of the dollar or the SPX, because it’s telling me how anxious people are about the next 30 days.
In the following posts I will write about volatility indexes on different asset classes, including recently introduced cryptocurrency implied volatility indexes. If you are interested in trading cryptocurrency derivatives I recommend Deribit- the most liquid crypto derivatives exchange operated by veteran options traders. They take all security and operational risks quite seriously and the platform is exceptionally robust.