Jun 12, 2022

Artur Sepp: Modeling Implied Volatility Surfaces of Crypto Options

This is a quick follow-up to my previous post with comments on Artur Sepps's video.

From the start Mr Sepp sets up the practical problem familiar to anyone in the crypto options space. The leader is Deribit - an exchange that I wrote about extensively in this blog with ~ 89% market share. The next biggest is CME with ~ 6% market share, and expected to grow. One would naturally want to trade and arbitrage between these two markets, however this is not a simple task. Ignoring for a moment the actual mechanics - lack of ability to directly transfer funds from one exchange to another, and lack of any cross-margin, the options on the exchanges are actually different. 

CME options are the "typical" dollar denominated BTC options, but Deribit options are inverse - they are Bitcoin denominated USD options. If you find this concept difficult, let me offer a simple example. Imagine you are a US-based trader speculating on the price of British Pound; it costs you about 1.23 dollars to purchase 1 pound, and let's say you are bullish on pound and decide to buy some 1.3 strike (slightly otm) calls. 

At the same time there is a UK-based trader, speculating on the price of USD ( in relationship to GBP ). It takes 0.81 (=1/1.23) pounds to purchase a dollar, and the trader is bearish on USD ( bullish on pound ) and decides buy some 0.77 (=1/1.3, slightly otm) puts. I hope that right now you realized that the two traders have identical financial views, and are performing (almost) identical financial bets. 

The same situation is with CME and Deribit options - same options but currency is inverse. CME would be the familiar - you live in a dollar world and trade BTC, and Deribit would the in "inverse" - you live in a bitcoin world and trade USD. The question is how to price both sets of options without arbitrage.

From the start to about 20th minute in the video Mr Sepp explains how the markets are organized, basic description of expiration schedules, skews, and regimes. I am not going to review this here - watch it yourself, this is gold!

The rest of the video until about min 50 is spent on introducing the model, empirical justification, solution, and calibration to the exchange data. If you are a quant programmer - this is the portion of the video for you; if you are a trader - watch the first 20 minutes then skip the next half hour. 


Now I want to address the situation in Ukraine. In my post from Feb 25th I wrote that the goal of Russian war is the genocide of Ukrainian people. Maybe at that time you dismissed it as me being hysterical, but after the events in Bucha and other Kyiv suburbs that we liberated I hope this is plain and obvious that I was correct. And the news that we are getting from the areas still under occupation are much much worse -  systematic murders of journalists, kill lists of political and cultural leaders, destruction of factories and key businesses, hospitals, schools, and libraries, burning of history books.

 I want to thank everyone who acted to help Ukraine. Thank you Quantocracy for pinning my Feb blog post on your website and spreading the message to your audience. And to my readers, I ask you again to do two concrete, low-effort things that help Ukraine:

1 - Please reach out to your political representatives! Call and leave a message for your senators, congressmen, members of parliament, to allow sales of weapons to Ukraine, request faster delivery of weapons, and to impose more sanctions on Russian individuals responsible for war and on Russian government to slow down the war economically.

2 - If you are working with Russian businesses, or individuals in Russia, please join non-military resistance. If you are processing payments to Russia - delay them by one day, if you are providing tech support - de-prioritize it, if you are sending an email to Russians mention "Russian warship". And, yes, cultural events too - this sends a strong message that Russian behavior is not acceptable. And these small things matter - in a recent interview with Putin, Russian students complained that it is difficult to work with people in other countries. That is exactly what I am asking you to do: make it difficult! More difficult means less war.

And, again, thank you to everyone who acted - thoughts and your prayers are not stopping murders, it is your actions that make a difference! 

My sister keeps her two cats in a schoolbag when hiding in a basement during Russian air raids.



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