At time of writing (26 March 2019) Bitcoin Volatility is nearly back to lows of mid-November 2018. Buying opportunity? But how do you buy something as intangible as volatility?

Buying and Selling Bitcoin Volatility Using Bitcoin Options

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This is Part 2 of a 3-part Primer to Trading Bitcoin Options.

Part 1 Trading Bitcoin Options at Deribit explained the simple mechanics of buying Call and Put Options. Buying Options is a limited risk trade.

Part 2 explains how to buy and sell Bitcoin volatility and profit from changing volatility regardless of price direction using options strategies.

Part 3 will explain how to use the Bitcoin Options Calculators at my site AntiLiquidation, and specifically how to calculate PnL, Maximum Gain & Loss, and Break-Evens before you enter a Bitcoin Options trade. (Deribit has no Options Calculator on its platform.) Part 3 will treat the subject of selling options, also known as writing options, which is much riskier than buying them and carries unlimited risk. It will also take a look at Options strategies, and delve into the Greeks.

Risk Warning

Most options expire worthless and the premium is lost by the buyers of those options to their writers. Options are excellent for hedging but are not a great vehicle for speculation except in specific, unusual circumstances.

Buyers of options are likely to lose what they pay. They will lose money slowly and then quickly as theta decay accelerates as expiry approaches. That said, buyers’ risk in buying options is limited to the premium they pay at the outset, and buying options is less risky than writing them as sellers face margin-calls and unlimited risk.

With those caveats in mind, in my opinion the current low Volatility + high Open Interest state of the Bitcoin futures market represent a great chance to make money from buying volatility. (Current at 26 March 2019.)

Low Volatility

At time of writing (26 March 2019) Bitcoin volatility has been falling all through 2019 and is approaching its mid-November 2018 lows.

‘The next break of Bitcoin is going to be significant’. Which direction will you pick with your XBTUSD swap or futures trade? A thousand traders on Crypto Twitter will give you their TA-based opinion. Probably about 50% will be right. Or how about buying the volatility so you benefit whichever way the price breaks? The only place you can buy Bitcoin volatility is at the only Bitcoin options exchange. Open an account at Deribit.

The last time Historical Realized Volatility reached these lows, in mid-November 2018:

Buying Bitcoin Volatility has been a great trade whenever its annualised value falls below 30%.

There is an incredibly clear pattern that months with low Bitcoin volatility are followed by months of high volatility. Table created by @Rptr45

+ High Open Interest

Open Interest is the total number of open derivatives (futures or options) contracts. For each buyer of the Bitmex swap there must be a seller. From the time the buyer or seller opens the contract until the counter-party closes it, that contract is considered ‘open’. OI is (together with volume) an indicator of derivatives liquidity. The high OI shows that the current low volatility is not a function of traders getting bored with Bitcoin and quitting the market. There is tremendous liquidity stacked up waiting for price action.

How to Trade Bitcoin Volatility

Equity traders can Long and Short US equity volatility by trading the VIX Future. VIX - the ticker of the CBOE Volatility Index - measures the stock market’s expectation of volatility implied by S&P 500 index options. You cannot trade Bitcoin volatility using the swaps and futures at Bitmex or the CME as there is no volatility contract. It can only be done indirectly, the old-fashioned way, by trading Bitcoin options at Deribit and specifically buying and selling straddles & strangles.

Buying Bitcoin Volatility

Buy a Straddle

A straddle is an options strategy to buy volatility by buying a Call and a Put, both At-The-Money. (i.e. Strike is equal to the price of the underlying.)

First choose your expiry. There is a choice between building a larger, cheaper straddle at 26-APR or a smaller, more costly one at 28-JUN. I like the former, as it provides more bang for bucks. And my belief is that price will break in the next month.

Buy the Call and Out at the strike closest to the underlying price. That means buy at the 4,000 strike.

We get this PnL chart:

Note how incoming volatility — where the price breaks below or above the current $4000 level, guarantees profit for the buyer of the straddle. The straddle will bleed time value as long as the price remains close to $4000. Charts thanks to Sheet published by @cryptarbitrage.

Buy a Strangle

A strangle is an options strategy to buy volatility by buying a Call and a Put that are both just Out-Of-The-Money. (i.e. Call Strike > the price of the underlying, Put Strike <the price of the underlying .)

The strangle is cheaper than the Straddle. It has a higher Risk-Return. If volatility stays low then you are more likely to lose everything you stake.

That means buy the 4,250 strike Call and buy the 3750 Put.

You might also think about a strangle at 4500/3500.

PnL chart:

Charts thanks to Sheet published by @cryptarbitrage

How to Sell Volatility

Sell it when it is high. But this is an ultra-risky strategy.

Table created by @Rptr45

The PnL for selling the straddle is simply the inverted PnL for buy the straddle. Selling volatility is much riskier than buying it. You face unlimited risk. Selling volatility should be left to experienced options traders.

Charts thanks to Sheet published by @cryptarbitrage

The great risks of selling volatility are shown in the case of James Cordier of OptionsSellers, who sold volatility in energy markets in November 2018. There was an explosion of volatility in those markets, and his clients lost their entire accounts, and were liable for margin-calls over and above that.

31 March 2019: If this primer was helpful then you can pay a Bitcoin Tip on Lightning [ link]

Resources for Bitcoin Options Traders:

Crypto Analyst. BitMEX Expert. Deribit Bitcoin Options Trader. Made