Volatility is a complex statistic often used by traders and investors. Those unfamiliar with it probably attribute analysts a special “status” when the term is used. But as explained in a recent comment from Binance Exchange founder Changpeng Zhao, in most cases people do not know what volatility is.
This was not the first time Zhao made a wrong assumption about this. Zhao said in May that volatility is “not unique to cryptocurrencies”, although several sources including Cointelegraph showed that, with the exception of Tesla, no S&P 500 can match Bitcoin (BTC) 70% volatility per year.
So what is volatility?
Realized (or historical) volatility measures how large daily price fluctuations are, and high volatility indicates that the price can change significantly over time in both directions.
This indicator may sound counter-intuitive, but periods of low volatility pose a greater risk of explosive movements. This is partly due to the volatility achieved as a falling indicator. In quieter periods, traders tend to overuse leverage, which then leads to greater liquidations during sharp price movements.
Bitcoin volatility over 50 days. Source: TradingView
The data above show an average of 74% 50-day volatility over the last two years. Historically, the indicator tends to accelerate when it moves above 80%, but there is no guarantee that such a move will occur. The data for February and April 2017 provide a counter-argument to this thesis.
Volatility does not differentiate between bull and bear markets as it measures pure absolute daily fluctuations. Moreover, a period of quiet hesitation is not in itself a sign of an impending landfill.
What if Zhao knew something we do not know?
Given how connected the world’s largest cryptocurrency exchange entrepreneur is, there’s always a possibility that Zhao has some inside information, but if anyone is very sure of an upcoming event, they’ll probably know if the effect is positive or negative. Again, expecting “high volatility” over the “next two months” does not mean that a person is safe in any direction.
Let’s say he is right, and the volatility of the cryptocurrency is about to go beyond the 100% annual level. It is an option strategy that fits this scenario and allows investors to capitalize on a strong move in both directions.
Reverse Iron Butterfly (Short) is an option trading strategy with limited risk and limited rewards. It is important to remember that options have a specific expiration date; Therefore, the price increase must take place in the specified period.
Profit / loss estimation. Source: Deribit Position Builder
The prices above were taken on October 25 when Bitcoin traded around $ 63,000. All the options listed expire on December 31, but this strategy can also be used with other time frames.
The proposed bullish strategy consists of selling 1.23 BTC put options worth $ 52,000 while selling 0.92 call options with a strike of $ 80,000. To complete the trade, you need to buy $ 1.15 $ 64,000 call options and further 1.0 $ 64,000 put options.
Although this call option entitles the buyer to the asset, the seller of the contract receives negative (potential) exposure. To fully protect against market volatility, 0.174 BTC (approximately $ 11,000) must be deposited, which is the maximum loss for investors.
The risk of reward is minimal, so the trader must be convinced
For this investor to make money, the bitcoin price must be below $ 54,400 on December 31, 2021 (down 14%) or above $ 75,500 (up 19%). The theoretical risk reward is low because the maximum payout is 0.056 BTC and the potential losses are more than three times that amount.
However, if the trader is sure that volatility is about to occur, a move of 20% from $ 63,000 in 66 days seems possible. Traders should be aware that the investor may repeat the process before the options expire, preferably immediately after a strong bitcoin price movement. All that is needed is to redeem the two options sold and sell the other two options that were previously purchased.