Volatility Labs
Advanced volatility analysis tool to help you grasp the market context.
Last updated
Advanced volatility analysis tool to help you grasp the market context.
Last updated
In SignalPlus Toolkit, you will find a series of advanced tools to display volatility related information from different angles, under the Volatility module. And we will review them one by one.
As discussed in some of our other articles, implied volatility projects the likelihood of future price changes in a given asset. Among the 4 factors (moneyness, time to expiry, and interest rate, implied volatility) that affect option pricing, IV (implied volatility) is the only subjective component that can't be observed directly. Given an option price at a specific moment, as the other 3 objective factors are known, it is fairly easy to derive IV from option price using the Black-Scholes Model.
The benefit of using IV instead of dollar price to compare different options is evident - it is a standardized unit of measure that can be applied across different strike prices, expiration dates, and even underlying assets.
In a word, IV is one of the most important measures for options traders to gauge the market sentiment and we want to use IV to help us find hidden opportunities or manage upcoming risks.
The term structure of IV describes the pattern of options with the same delta exposure but different maturities. By comparing term structures, investors can visualize how option IV will change as time elapses. As per the chart below, longer tenor options currently have higher IV than shorter tenor options, implying that longer tenor options take more uncertainties of the future into consideration.
By default, our system displays a standardized set of strikes. 25D Put represents a Put whose strike has been chosen such that the delta is -25%; 25D Call represents a Call whose strike has been chosen such that the delta is 25%. You can also choose a different delta representation for your purpose on the left side.
By observing the IV gap between different delta, investors can also gauge RR IV. RR is a portfolio of long call and short put at the same delta, which is commonly used for gauging market emotion. When call iv-put iv is negative, investors are trading put for downside protection. When call iv-put iv is positive, investors are trading call chasing up trend.
When we plot IV of various options with the same underlying asset and same expiration date but different strike prices, we often see a U-shape (or a smile) towards the polar ends of the curve. This means volatility increases as the option becomes increasingly in the money or out of the money.
However, please note that volatility smile is not always symmetric, especially in longer-term options. In the case below on a further expiration date, the smile is reverse skewed, meaning the IV for options at the lower strike price is higher than the IV at the higher strike price. This suggests that ITM calls and OTM puts are more expensive than OTM calls and ITM puts. On the other hand, if IV for options at the lower strike price is lower than the IV at the higher strike price, then we call the smile forward skewed.
The most popular explanation for reverse skews is that investors are generally worried about market crashes and buy puts for protection (the snapshot below is taken shortly after BTC falls under $19,000). One piece of evidence supporting this argument is the fact that the reverse skew did not show up for equity options until after the Crash of 1987.
In conclusion, not all options align with the volatility smile. Fortunately, Model Volatility Smile provides you with a visualization to manage risk intuitively.
Let's expand the volatility smile a bit further, keep the strike price as the x-axis and IV as the y-axis and if we add different expiration dates as the z-axis, we get a 3-dimensional plot of the implied volatilities of the various options listed on different dates. This is called Volatility Surface. One quick alternative is that we usually translate different price points to the corresponding delta for calls and puts.
Through volatility surface, it becomes even more clear to traders how IV shifts as price/delta and time to expiry change.
Implied Volatility (IV), as we know, aims to forecast the expected price movement of an crypto asset; Realized Volatility (RV), on the other hand, indicates how the price of the underlying asset has moved over time.
Options traders can use IV vs. RV graph to contextualize the IV being quoted by the market. More often than not, markets tend to overestimate IV, which provides an opportunity for savvy traders who strive to capitalize on perceived mispricings of IV. Historically, IV tends to revert to the mean, which makes contrasting it to RV quite useful.
Volatility cone is a visualization of historical volatility variation ranges. It is a useful tool for estimating possible IV/RV range.
The data is derived from a certain period (in 1 year period for the case below). The horizontal axis represents the size of the observation window in days while the vertical axis represents the annualized volatility. For a certain observation window, we can derive several different RV (realized volatility) values in 1 year period. Analyzing these RV values statistically, we can plot extremums and quantiles of RV in each observation window. Meanwhile, the dotted line represents the latest RV for each expiration period.
As you can see, the variation in annualized volatility is large when the window is small and gradually converges to a narrower range as there are fewer and fewer samples for longer observation windows.
Through this chart, users can find out the current RV in relation to the historical RV. Along with other data, traders can make a more informed projection about whether the future RV will rise or fall.
Since RV is an extremely important factor for us to understand the market sentiment for the past period and make informed decisions for the future, understanding the momentum of the RV can be crucial as well. 7D RV momentum represents the speed of RV change on the trailing 7-day basis.
A high level of RV momentum means RV is moving up aggressively lately. In this case, traders need to pay more attention to RV/IV related risk exposure, such as Gamma. Mathematically, RV momentum is defined as the derivative of RV with respect to time in day.
When there is an unexpected event impacting the underlying asset, RV could shoot up dramatically. By observing the change of RV momentum after the event, we are able to make an educated guess about whether RV is going back to normalized level or staying at higher level for a longer time.
As we mentioned earlier, IV is the key factor to gauge the market sentiment and the price of options. In order to see the change in sentiment and the price over time, we introduced 2 widgets to see the historical trend of IV.
The first is historical IV by tenor. The horizontal axis displays the time series and the vertical axis represents the level of IV at that time. On the left side of the graph, you can select the tenor you would like to display on the chart.
The other is historical IV by expiry. Similar to the one above, the horizontal axis is the dates and the vertical axis is the level of IV. However, instead of presenting IV of the options by tenor, the graph shows the IV change over time under different expiration dates.
Right above the tenor or expiry selection, IV for ATM options are selected by default. However, you can select calls or puts with different delta, and even Risk Reversal (RR) or Fly.
25D RR, for example, is defined as (25 Delta Call IV – 25 Delta Put IV). Essentially, it is the difference of implied volatility of similar call and put options. Implied volatility is indirectly related to the demand for call and put options. When the market has a huge need for downside protection, IV for puts is much higher than for calls, thus creating negative RR.
25D Fly, on the other hand, is defined as (25 Delta Call IV + 25 Delta Put IV) /2 – ATM IV. This measures the curvature of volatility smile. When Fly is high, volatility smile is steep on both sides, or IV of similar calls and puts are much higher than IV of ATM options.
Through the historical IV graphs, the users can review the movement of IV intuitively in the selected time frame, and capitalize trading opportunities instantly within SignalPlus trading module.
A different way to view the change of IV from prior periods is called Time Lapse IV. Our platform also provides 2 ways to view the time lapse IV.
The first one is time lapse IV by tenor. The horizontal axis shows the tenor of the options and vertical axis is the level of IV or RV. Each line represents a snapshot of data at a specific time. For example, the graph below shows, for ATM ETH options with 14-day tenor, the current RV is about 70%; IV is 62% 30 days ago; IV is 57% right now; IV is 50% 7 days ago.
The other one is time lapse IV by expiry. Instead of presenting horizontal axis as tenor, this graph uses different expiration dates as horizontal axis. To be more specific, the instance below says that for ATM ETH options with expiry of April 28th, IV 30 days ago is 60%; current IV is 56%; IV a day ago is 54%.
In addition, you can choose IV of other options and strategies, such as 25D Put, 15D Call, Risk Reversal, and Fly. And you can choose any other data points by entering different dates as well.
By using Time Lapse IV, users can get intuitive comparison of IV change on different tenors/expiries. In combination with Historical IV, traders would be able to see the full picture of the market and make timely decisions.
