FTX BVOL Token: the Bitcoin Market’s First VIX Product

Disclaimer: This article is not investment advice. It is just a discussion of the new FTX volatility product BVOL (previously announced as BVIX but changed). Trading is risky.

Based on support articles on FTX.com, they will be releasing a new 1x ETF token called BVOL (long volatility) and iBVOL (short volatility). These tokens represent a broad set of long or short positions on the FTX MOVE contracts, which represent volatility in bitcoin price. To understand better how these tokens work I’ll start with how the underlying MOVE contracts work.

MOVE Contracts

An FTX MOVE contract is a futures contract that settles to the absolute value of the dollar movement of BTC:USD within a certain period :

MOVE Contract value = abs(BTC:USD Index Value at Start of Period - BTC:USD Index Value at End of Period)

This defines volatility as the magnitude of BTC:USD index price deviation (positive or negative) from start price to end price, this is not the same as a statistical standard deviation calculation!

So whether the BTC:USD price goes UP or DOWN a certain amount from the start price of the period, it settles at the magnitude of the price change for a given period.

The contracts are traded like futures contracts (with margin) on a central limit orderbook of bids and offers that you can long or short. So when the contract launches there are marketmakers providing bids and offers guessing how large the price will move for the specified period, and you can short or long if you believe volatility will be lower or higher.

MOVE’s settlement is based on the underlying BTC index which drives FTX’s other BTC:USD Futures, the index is comprised of top spot markets:

For example: let’s say there’s a daily MOVE-0416 contract. It settles to the daily price change on April 16, so between price in the first hour of the day: 00:00–00:59 and the last hour of the day 23:00–23:59 (a time weighted average price through the hour).

If the BTC:USD index price for the first hour of April 16 is $6,666 at the end of the day it’s $6,800 then the MOVE contract settles to $134. Same would value would settle if the BTC:USD price was $6,532, -$134, since MOVE settles to the absolute value of the change.

As the trading day moves along and price fluctuates, the market for MOVE will also fluctuate because marketmakers and other traders expect a different deviation at the end of the day versus start price. For example, if price stayed around $6,666 mid-way through the day of April 16, then the quote for the market for the contract might be $60 or so. This is because there’s still many hours that the market can move so they wont price it at too close to $0 since as any bitcoin trader knows the price can still move up or down in the final hours of the day quite a bit so it would be crazy to sell too low.

So if you jumped in and bought at $60 mid-day and waited for settlement at $140 you would earn $80 per contract. Plus you can sell it in the market before settlement, as the market value fluctuates. And you can of course short it like any other futures contract if you expect lower volatility. When long, you can only lose the value that you spend on the contract — but be careful because you can also trade on margin.

Note that the MOVE contracts have a start trading quote in the market that usually represents a simple expectation of the daily dollar movement of the underlying price, so maybe it will be about $150 to start (if you were to guess based on say the average the daily dollar value movements the past 100 days or so). However, if big volatility hits the market you can expect higher quotes as expectations will also be higher. As such, if you thought volatility would die down, shorting a MOVE contract that is in the orderbook priced at $150 which ends up settling at $1 because the price barely moved all day, means you make $149 per contract.

In summary, MOVE contracts have a few notable characteristics:

• Valid period: Start Date — End Date
• Strike price: Price of underlying at Start Date
• Settlement price: Price of underlying at End Date
• Launch date: Date where MOVE contract begins trading, can be before Start Date.

The market in the UI looks like this:

Notice “strike price” and the possibility to profit whether market goes up or down.

Does this structure look familiar?

If this made you think about options then you’re right.

The dollar amount at which the underlying price moves can be replicated in the options market by doing a straddle, where you buy both a put and a call option at the same expiry and strike (with strike price being at-the-money, aka same as spot price). This is a play where you are long volatility — in either direction. All you care about is that the price explodes either up or down, in a magnitude that exceeds the premiums you paid to buy the put and call.

If you buy a put and a call with the same strike equal to spot, and paid $50 in premiums for both, you can’t lose more than the $100 spent. But to profit, you want the price to move in spot more than $100 either up or down (vs strike price) in order that one of your options earn money. Just like if you buy a MOVE contract for $100 you want the movement vs start price, up or down, in BTC:USD index to exceed $100 for you to make any actual money.

What does this mean? Well, if it’s not obvious yet — MOVE contracts can be represented as just straddle trades in the options market — as long as the strike price is known!

The Options Market

This article isn’t a tutorial on options, but I will mention that Deribit has the most liquid and open markets for Bitcoin options. I will use their market to compare the quotes on FTX’s MOVE contracts with the options market to see if the pricing is at fair value.

In this example I will focus on the 26th of June expiry Deribit options, and the FTX BTC-MOVE-2020-Q2 contract, which has a $6813 strike price and expires on the 26th of June:

FTX MOVE Contract for Quarter expiring June 26, 2020

Deribit Options Market for Expiry 26 June 2020

So if you wanted to “long volatility” by buying this quarterly MOVE contract, you would pay $2,217 on FTX.

On Deribit you would have to find the closest strike which would be $7,000 and hit the ask side for 1 BTC worth, which is $1,203 for the Put and $1,072 for the Call, for a total of $2,275.

The pricing is a bit off because the strike on FTX is $6,803 and the closest strike on Deribit is $7,000 — but you get the idea, the pricing of MOVE converges to the fair market value in the options market to replicate the trade using a straddle. In this case we basically confirm that FTX is trading at a fair price vs. the known pricing of top options market.

Now, before I get to discussing the BVOL and iBVOL token, I want to go over a few key concepts and a small history lesson.

Implied Volatility

So what exactly is implied volatility? In the screenshot above of Deribit’s option market you notice a column for “IV”. This is computed based on the Black-Scholes formula for fair market options valuation. This formula is established as the standard for how to compute the fair value of an options contract given a number of key observable variables in the market:

Valuing call (c) and put (p) options using Black-Scholes

The inputs for this are as follows:

• c / p = the market price of the option for sale (call or put)
• S = the underlying spot price (BTC:USD)
• K = the strike price (multiple strikes offered per expiry)
• T = the time to expiration (expiration date minus current date)
• r = the risk-free interest rate (0% on Deribit)
• σ = volatility

In the case of the options market we have the market value of the call/put, we have the underlying spot price, we have the strike price, time to expiry, and assume r=0% for BTC (can quibble over this but it’s what Deribit does so we stick with it). So to compute the final figure, σ, we just input all the aforementioned values observed in the market and solve for what is known as implied volatility (IV).

The VIX

This brings us to the famous VIX, the volatility index, produced by CBOE. You can read the long boring white paper here. The long and short of it is that it uses the S&P options market to compute a weighted-average of out-of-the-money implied volatility (using the formula discussed above) to get a metric that represents the market’s estimation of 30-day volatility for the S&P, based on the options market prices.

Because this figure is based on the options market, the CBOE is able to run VIX Futures which settle at various periods based on the weighted-average of implied volatility in the options market. Having a volatility measurement which is market-based enables them to provide healthy amounts of liquidity because the marketmakers are able to hedge the exposure to volatility by taking positions in the options market. Pretty cool, right?

BitMEX’s Failed BVOL Contracts

Five years ago, BitMEX was running a type of bitcoin volatility contract called BVOL. Its formula was to compute realised volatility for the day, i.e., the standard deviation of the log returns every 5 minutes of the underlying BTC:USD index.

Back then there was no options market, not even a bad one (unless you count Coinut). There was occasional OTC activity of options but nothing resembling any coherent Central Limit Orderbook (CLOB) market. So BitMEX had no opportunity to run a volatility contract that was based on market rates and could be easily hedged. The next best thing was the differential between their XBTUSD quanto contracts (which traded at decent premium to spot) and the XBTUSD inverse contracts (trading lower than quanto). Since quanto payoff was linear in BTC and inverse is inverse, you could long Quanto, short inverse and yield for payoff P: Quanto - Inverse= P * (P - 1/P) = P^2 - 1. Not bad, a half-retarded strangle play, which is the same as a straddle but using out-of-the-money strikes.

However, this wasn’t quite good enough. And instead of a nice market-based volatility measure like VIX, they ran a simple realised volatility std. deviation computation to settle futures on volatility. AND LIQUIDITY ABSOLUTELY SUCKED! But I didn’t care, I traded this religiously. I was just happy to have a way to take punts on volatility. My main idea was to just long the shit out of BVOL contracts day in and day out (waiting for about 12 hours of flatness before doing so) and wait for a nice pump.

I also used to look for underpriced contracts in the market by computing what the minimum realised volatility would be in the market (just by assuming a flat price for all the remaining periods). It worked sometimes, but mostly I enjoyed the exercise of analysing the market in a systematic way.

Below is a screenshot of my old ad-hoc spreadsheet tool used to compute minimum daily volatility and find opportunities in the market:

Mr. Wannabe Quant with his shitty spreadsheet tool

Enough of the memories — the main reason I bring this up is that the orderbooks on BitMEX’s BVOL contract were pitiful. There was no options market, as mentioned, and the computation of the realised volatility using standard deviation was not quite the same measurement you would get in the implied volatility measurement in an options contract on the open market. As a result, it was very difficult for “marketmakers” on BitMEX to provide thiccc liquidity in the books because they wouldn’t really hedge the risk by longing volatility themselves. As a result, the BVOL contract died a quiet death in early 2016, as BitMEX shifted its focus from offering quanto and inverse side by side and instead doing a 100x Perpetual contract.

BVOL and iBVOL: Closest thing to VIX

So to recap:

• 2004: CBOE launches VIX futures to let traders get exposure on volatility on S&P derived from Options market for S&P
• Early 2015: BitMEX launches BVOL contracts, and lets one trade volatility by doing a pseudo-strangle using quanto and inverse futures
• Summer of 2016: Deribit launches first liquid options market for BTC, allowing people to trade volatility cleanly using straddles in their vanilla options market.
• 2019: FTX launches the MOVE contracts (later copied by Delta.Exchange) which provide a simpler user-friendly way to make a straddle play in the market using futures-type contracts where you long or short the period’s $ move (absolute value). OKEx joins Deribit in running a liquid options market.
• 2020: FTX launches what I would consider the closest thing to a real VIX product to date: BVOL

Now, I love trading the VIX contracts on S&P so I have been waiting for a while to be able to take volatility plays in bitcoin the same way where you can get a nice index of the IV’s from the options market and just trade that instead of dicking around in the often illiquid books of the individual strikes for options.

So how does FTX achieve an analogue to this? As of now, April 14, 14 UTC, FTX currently runs the following MOVE contracts which expire end of day of specified date:

• 24-hour period: BTC-MOVE-0414 (“Today”, strike price known)
• 24-hour period: BTC-MOVE-0415 (“Tomorrow”, strike price unknown)
• 7-day period: BTC-MOVE-WK-0417 (“This week”, strike price known)
• 7-day period: BTC-MOVE-WK-0424 (“The week starting next week”, strike price unknown)
• 7-day period: BTC-MOVE-WK-0501 (“The week starting in two weeks, strike price unknown)
• 7-day period: BTC-MOVE-WK-0508 (“The week starting in three weeks, strike price unknown)
• 3-month period: BTC-MOVE-2020Q2 (“This quarter, strike price known”)
• 3-month period: BTC-MOVE-2020Q3 (“The quarter starting next quarter, strike price unknown”)
• 3-month period: BTC-MOVE-2020Q4 (“The quarter starting in two quarters, strike price unknown”)

So at any given time for the 24hour-period MOVE contracts, Week-period MOVE contracts, and Quarter-period MOVE contracts available on the market, there is one of each that has a known strike price, which will simply reflect the market value of a straddle with the strike price matching the options market.

The rest of the 6 contracts (a 1 day, three WEEK, and two QUARTER contracts) have unknown strike prices because their respective valid periods have not yet begun. Remember each one settles to the Settlement Price minus the Start Price of Period, but some contracts are launched BEFORE the start date, so there is a period between the launch date and start date where the strike price is unknown and the market is trading at a price representing an anticipation of the volatility to be experienced in the valid period.

ETF Tokens

Now, FTX has launched its BVOL and iBVOL as one of its ETF Tokens (currently they run leveraged tokens on many cryptocurrencies which are liked leveraged ETFs mimicking 3x long/short returns and 1x hedge). You can imagine it like an account on FTX that is dedicated to taking positions and you own an equity stake in that account, which has a certain market value.

The way this works is just like an ETF but in ERC20 token form: they choose an underlying basket that represents a position on the FTX market. Then they have an creation and redemption process that matches the basket value where “shares” (tokens) can be created or destroyed. Behind the scenes are active market positions in FTX contracts that back the tokens. The net effect is that there are transferable ERC20 tokens, which have a market value equal to the underlying basket, that can be traded on any spot markets.

This is an important point: BVOL and iBVOL are ERC20 “ETF tokens”, they are _not_ futures contracts. You buy and sell BVOL and iBVOL tokens just like any spot ERC20 token, and let FTX handle the rebalancing and creation/redemption process for the underlying fund representing the value of corresponding MOVE contract positions.

Specifically, in the case of BVOL and iBVOL, FTX maintains a basket equal to 6 equal parts of MOVE positions:

• BVOL represents long positions in the six MOVE contracts w/o strike
• iBVOL represents short positions in the six MOVE contracts w/o strike

They don’t include the contracts with known strike prices in order to best capture the anticipated implied volatility priced in the market, and this can still be reliably hedged using a combination of options positions.

The tokens’ underlying funds are rebalanced every day to match a 1x leverage and also intra-day if iBVOL leverage gets too high from a jump in volatility. So the chain of effect is:

BTC:USD Spot Index Price Volatility Changes ->

BTC-MOVE Contracts Value Change ->

BVOL/iBVOL Token Basket Value Change->

BVOL/iBVOL Token Value Change on Spot Market

So whether you want to easily get long volatility (a good play before the March 12–13 dump) or short volatility (which was a good play after the March 12–13 dump) — these tokens provide you with a good approximation of what a BTC VIX contract would be.

Most confusing for some readers might be how the iBVOL works. The key thing to understand here is that volatility comes in clusters, so when there has been a shock like March 12–13, the MOVE contracts would be priced rather high due to expectation of price settling farther away from the start price. As such, if you want to bet against price having volatility, you buy iBVOL which will gain value if the price remains flat.

Why FTX Volatility Contracts / Tokens will Succeed

As described before, BitMEX’s volatility contracts were not terribly successful. Maybe it was too early for its time, but more likely it was because there was difficulty in marketmaking such an instrument because of how it was designed and because of a lack of an options market providing the ability to hedge volatility exposure.

In 2020 however, things are different. There are multiple options markets, CLOB and OTC, and the MOVE contracts on FTX have been popular which has helped price anticipated implied volatility well.

This means Alameda, and other marketmakers on FTX, are able to quote bigger sizes on MOVE contracts (and hedge using options) so that traders in the market can jump in and out of positions without crossing giant spreads and having a bad experience.

Conclusion

The construction of BVOL allowing a trader to get broad exposure to the volatility contracts over the next 8 months on different periods is the closest thing the bitcoin market has gotten to a true VIX instrument yet.

FTX has done a great job with its unique product offering on Index Futures, Leveraged Tokens, and MOVE contracts and now they are taking it to the next level with a BVOL token which captures a broad exposure to implied market volatility from the various MOVE contracts that don’t yet have a strike price.

There is an ongoing 0.03% a day management fee on the BVOL and iBVOL tokens that one should consider, plus a 0.10% creation and redemption fee (with slippage). So it’s ideal to trade the tokens in the actual spot market on FTX.

While it would be ideal to have a pure futures contract on a bitcoin volatility index in the spirit of the classic CBOE VIX, this BVOL token comes close by using the MOVE contracts (straddles) of unknown strike on FTX to get a broad exposure to anticipated implied volatility in the market.