Bitcoin Volatility Index (BVIN) Methodology & Use Cases
CryptoCompare recently launched the Bitcoin Volatility Index (BVIN) developed in partnership with the University of Sussex Business School. This is the first benchmark index to quantify bitcoin implied volatility and in this post we are looking at methodology and use cases for the Bitcoin Volatility Index.
What is a Volatility Index?
Volatility indices are widely used in the financial sector to measure the price volatility the market is expecting in the future at a certain maturity for a given asset. The higher the value of the index, the more volatility the market is expecting. Volatility indices are often referred to as “fear gauge” indices, as it is said that they provide a measure of “investor fear”.
Well-known volatility indices include the S&P 500 volatility index (VIX), the Gold volatility index (GVZ), and the Oil volatility VIX index (OVX).
The Bitcoin Volatility Index (BVIN) is the first of its kind in the digital asset industry, and measures the volatility the market is expecting for bitcoin’s price in the next 30 days.
Methodology
The index methodology is based on the implied volatility of put and call options traded on Deribit exchange. Option prices indicate how likely the underlying asset is to reach a certain price level, in this case, the strike price (price at which you have the right to exercise the option when it expires).
Intuitively the more probability the market assigns to the underlying moving towards a certain strike price, the higher the traded price of those options. Thus, if options with strikes far away from the current price of the asset are being traded at relatively high prices, the volatility of the underlying asset will be higher, meaning that the market believes that there are possibilities of large price movements.
To calculate the index at a certain moment in time, we use put and call options in which the expiration date is the closest to the next 30 days from our selected moment in time. For example, we take the options that expire 28 days and 40 days after our selected moment in time, as those are the closest maturities to 30 days from now being traded.
We then calculate the implied variance from the selected options and the average is taken between the 2 implied variances, putting more weight on the variance of the options whose expiration date is closer to 30 days (in our example 28 days). As commonly done in finance, the final number is presented as a volatility, i.e. an annualised standard deviation, measured in percentage points.
As explained above, higher values of a volatility index mean that the market is expecting greater movements in the price of the underlying asset. To illustrate these let’s compare Bitcoin Volatility Index values with Gold Volatility Index (GVZ).
Since 2015 the highest value GVZ has reached is around 50%, while the Bitcoin Volatility Index values have fluctuated between 50% and 300% in the past months. Thus, we can clearly see that the markets are expecting greater price volatility for Bitcoin than for Gold.
Use Cases
The Bitcoin Volatility Index could be used as the settlement price for Bitcoin volatility futures contracts and, if these futures become actively traded, their market prices may be used to construct indicative values for a diverse set of leveraged, direct and inverse Bitcoin volatility ETFs and other exchange-traded products. The Bitcoin Volatility Index will be the first index in the digital asset market that can be used as a settlement price for these purposes.
Additionally, this type of implied volatility index is a model-free fair value for variance swaps, which are traded OTC in traditional markets and on-chain for bitcoin.
Volatility index derivatives are very appealing to hedge funds for example, as they help diversify their portfolios. This is because volatility and returns are usually negatively correlated, and the market crash on March 12th earlier this year exemplified this: Bitcoin crashed over 50% from peak to trough in a couple of days, and during this period the Bitcoin Volatility Index rose to nearly 200%.
Taking a closer look into what happened to the Bitcoin Volatility Index during the recent Bitcoin rally we can see that, as Bitcoin reached a new all-time-high on 1st of December, the Bitcoin Volatility Index also went up, reaching almost 100%. Implied volatility rises when investors fear a crash, and it is a property that Bitcoin does not share with equity (although sometimes seen in gold) such a fear can be induced either from a price hike when the price is already near a peak, or a price fall when the price is at normal levels.
Learn more about the Bitcoin Volatility Index and CryptoCompare’s Index services.
