Volatility Trading with Options

Implied Volatility

Quedex offers the opportunity to place orders (in order book in Web App) in implied volatility (denoted as IV). Implied volatility is value of the volatility of the underlying asset such that, if we use it to determine price of the call or put european option in the option pricing model (such as Black-Scholes model), than the theoretical option price is equal to the observed option price (at the market). Hence, implied volatility can be interpreted as the market opinion of the volatility of the underlying asset price of the particular option.

Straddle

Straddle is the most intuitive way to trade Bitcoin volatility. We will see how to implement the trades that correspond to the expectations of rise and fall of the future volatility, respectively.

Straddle consists of a trading a call and put option at once. Note that underlying asset, strike price and maturity date have to be the same in the case of call and put option. Precisely speaking, when the options are bought, the strategy is long straddle, while if the short position in call and put option is opened, it is the short straddle.

Example - long straddle

Assume on the market you observe the following:

  • current Spot Price = $10,000,
  • Options are priced at Implied Volatility = 100%, for one-month european option with Strike Price = $10,000.

You expect that the BTCUSD exchange rate in one month is going to differ significantly from the current Spot Price, but you are unsure of the direction.

Further, assume that you would like to speculate on $10,000 notional of both call and short option contracts (Quantity = 10,000). From the Black-Scholes formula, you will bet 0.11040678 BTC (the total premium of call and put options). As a result, your P/L payoff would look as on the graph below:

In this particular case P/L is greater than 0 if the Settlement Price is smaller than ~$8,900 and bigger than ~$11,250.

We also see that long straddle risk is capped by the option premium paid and profits may be unlimited.

Example - short straddle

If you expect that BTCUSD exchange rate will not fluctuate “much” (remain relatively stable), you can perform short straddle strategy. As before assume that:

  • Spot Price = $10,000,
  • Strike = $10,000,
  • Implied Volatility = 100%,
  • Quantity = 10,000 (10,000 - short call; 10,000 - short put),
  • Maturity = 1 Month.

Recall that from the Black-Scholes formula combined option premium equals to 0,11040678 BTC. In this situation we have:

In order to gain profits Settlement Price has to be from the interval ~($8,900; $11,250). The profits are capped by the option premium, while the risk is unlimited.