In this article, we will cover some examples of how to trade the volatility of an asset, rather than the price of the asset. To help us, we will use several different products that are available on Deribit, including but not limited to the options. We will as much as possible remove our exposure to the direction of the underlying price, while retaining our exposure to the magnitude and frequency of price movements (the volatility).

Please note: It is assumed that the reader is already familiar with the details of calls and puts, and has some familiarity with both realised and implied volatility. For more information on these subjects see our option course here. No opinion is offered on when or if any of the mentioned strategies are appropriate for each trader. That is for the individual trader to decide.

The prices of option contracts are significantly affected by the volatility of the underlying asset, and more specifically by the market’s expectation of volatility. This makes them very useful for traders who want to speculate on volatility.

Straddles (long and short)

Most option trades are taking some sort of position on volatility, even if it’s not the primary focus of the trade, but let’s first look at a structure that is commonly used to bet specifically on volatility, a straddle.

A long straddle involves purchasing both a call and a put option at the same strike price and with the same expiry date. The strike price will typically be close to the current underlying price when the position is opened. When simply held until expiry with no further adjustments, the long straddle makes a profit when the underlying price moves far away from the strike price. The further the price moves, the more the long straddle makes. If the price stays close to the strike price, the long straddle will of course make a loss.

Even without knowing any of the maths or theory behind options or implied volatility, it’s possible to understand intuitively that this position is long volatility. When the underlying price doesn’t move much, a loss will be made, and when the underlying price moves a lot, a profit will be made.

To short volatility instead, the opposite position can be taken. Selling the call and put with the same strike price creates a short straddle, the exact opposite of a long straddle.

When held until expiry, the short straddle makes a profit when the underlying price stays close to the strike price. If the underlying price moves far away from the strike price, a loss will be made.

Moving back to the long straddle, it can achieve a profit if the price moves far in either direction, and at least initially it is neutral with respect to price direction (delta neutral). However, it needs the price to move far away from the strike in order to make a profit. A call and a put have both been purchased, typically at the money, so the cost to buy this position will often be high. As the underlying price moves away from the strike price, the long straddle will start to lose its delta neutrality, becoming an increasingly directional position, and no longer being a bet primarily on volatility. We can fix this problem with delta hedging which we will cover later.

A short straddle collects a large amount of premium up front, however this is only all kept if the price expires exactly at the strike price. The further away from the strike price the underlying price moves, the more the holder of the straddle will have to pay out, and there is no cap on this amount. A short straddle can also be delta hedged, which we will cover later.

Strangles (long and short)

A strangle is similar to a straddle, but involves moving the strike price of both the put and call out of the money. Some traders may be happy with the risk/reward profile of a straddle, but as was just mentioned, there are reasons why both sides of the straddle trade may prefer a strangle instead.

From the point of view of the long strangle, they won’t have to pay as much premium for their position. However, the underlying price also has to move further before one of their options is in the money.

From the point of view of the short strangle, they have a much wider range where the underlying price can end up while they still make a profit. However, their maximum profit will be much less.

Both straddles and strangles offer a simple way to get exposure to the volatility of the underlying asset, both via underlying price movements and via implied volatility (option prices). If implied volatility increases, this means option prices increase. This benefits the long straddles and strangles, and hurts the short straddles and strangles. Conversely, if implied volatility decreases, this means option prices decrease, which benefits shorts and hurts longs.

Dynamic delta hedging

As we touched on already, although both a straddle and a strangle will typically be roughly delta neutral when they are initially entered, as the underlying price moves in one direction, they will lose their delta neutrality.

For example, if we long a straddle which includes a call with a delta of 0.5 and a put with a delta of -0.5, then if we add our deltas together, our total delta is 0. Perfect, we are long volatility, with no preference for price direction.

However, now imagine the underlying price quickly increases several percent. This will be good for our position, but our call is now in the money and the put is now out of the money, so the deltas of our options may have changed to something like 0.6 for the call and -0.4 for the put. Now our total delta is 0.2, so as well as still being long volatility, we are also long the underlying price. If the underlying price then quickly decreases a few percent, completely retracing the previous move, we might be right back where we started. In this circumstance, there has been good volatility, but our supposedly long volatility position has not benefited from it because we just let our deltas run.

To fix this, and help our position benefit from volatility even if price then comes back to the strike price, we can hedge our deltas while the trade is open. To do this, we simply use a futures position to ‘cancel out’ the delta of our option position.

In our example, when we first enter the long straddle, our total delta is 0 so there is nothing we need to do. When the price first increases, our total delta changes to 0.2. To get our total delta back to 0, we should sell futures such that the futures position has a delta of -0.2.

At this point we would then have:

• Delta of 0.2 from our straddle
• Delta of -0.2 from our futures short

When the underlying price then falls back down towards the strike price, the delta of our options will go back to 0.5 for the call and -0.5 for the put.

We would then have:

• Delta of 0 from our straddle
• Delta of -0.2 from our futures short

Which leaves us with a delta of -0.2. To get this back to zero, we buy back our futures position, which in this case completely closes it.

Our options will be worth exactly the same as if we had not done any delta hedging of course, however now we have a profit from our futures short. Remember the underlying price increased, we then sold some futures. The underlying price then decreased and so we bought our futures back at a lower price than we sold them at. This profit from the delta hedge on the future has ensured that even though the underlying price has ended up back at the strike price of our straddle, we have still captured some profit for the volatility in the underlying price that we saw.

This simplified albeit slightly long winded example illustrates how if a trader is willing to be more active and hedge their delta, they can dramatically reduce the price direction exposure of their option position, making it a bet primarily on volatility itself.

Delta hedging won’t always lead to a more profitable outcome though. In our example, the underlying price moved back to the strike price, which is the worst place it could be for our long straddle, so of course any profit from hedging will look superior. However, if price moves strongly in one direction instead with no large pullbacks, the unhedged long straddle position would have been more profitable. Of course there is no way to know this will happen ahead of time, so it is up to the trader to decide what they want exposure to. If it is purely volatility exposure that is desired, then they will need to dynamically delta hedge their options.

DVOL futures

So far we’ve used options, and options in combination with futures to hedge our deltas. There is another product on Deribit though that allows us to trade a futures contract on a volatility index (DVOL, which is the Deribit volatility index).

The DVOL index gives us a single value for rolling 30 day implied volatility that we can trade futures on. For more information on exactly how this index is calculated see here.

The DVOL futures allow us to trade implied volatility more directly, without having to worry about where the underlying price is relative to our strike prices, or about actively hedging our deltas.

These are huge benefits, but there are also disadvantages. While this is a relatively new product, and so this may improve with time, the liquidity on DVOL futures is usually much lower than what is available on the options or the regular futures. There is also currently only one DVOL future available at a time. So there is more choice of expiry dates available with options, which not only gives more choice but also allows for trading relative volatilities between different expiry dates.

Despite these limitations, the DVOL futures offer another very useful way to speculate on volatility.

Summary

Traders wishing to speculate on volatility, can do so by utilising options. The buyer of a put or a call is long volatility, and the seller of a put or a call is short volatility. Some of the most common option structures to bet on volatility are straddles and strangles, because at least initially, they are roughly delta neutral.

However option positions that are initially delta neutral can pick up deltas as the underlying price moves (or as time passes). Delta hedging can be used to make sure the trader’s profit or loss is primarily based on volatility, rather than the direction the underlying price moves. This delta hedging can be done either manually or algorithmically.

Futures on a volatility index offer another way to bet on volatility, without having to worry about price direction or about delta hedging.

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In this article, we will explore the dramatic improvement in liquidity for Future Spreads on Deribit, and highlight who this enhanced liquidity will benefit the most.

What is a future spread?

Most traders will be familiar with the concept of trading a single future, with a long position on that future benefitting from an increase in price, and a short position benefiting from a decrease in price. Traders may also be familiar with the fact that futures contracts with different expiry dates can have different prices, even when they have the same underlying asset.

For example, Deribit offers several futures contracts on bitcoin at any given time that each expire on different dates, and the March contract will typically have a different price to the June contract. The June contract will also have a different price to the September contract etc.

This is a screenshot of the futures menu on deribit. In the Contracts column we can see the different futures contract dates, and the Price column shows the different prices for each of those contracts. For example, we can see that the bitcoin future contract that expires on the 29th of September has a mark price of $29,365.20, and the bitcoin future contract that expires on the 29th of December has a mark price of $29,781.60. In fact every future contract on the list has a different price.

The size of the difference between each of these futures contracts is also not static. It will change over time, and can be either positive or negative. The difference in price between two futures contracts can be traded using a Future Spread.

Future Spread order books

On Deribit, there are order books specifically for trading two different futures contracts in opposing directions in a single order. These are called Future Spreads.

How good is the liquidity?

To indicate just how good the liquidity has become for the Future Spreads, I took two random snapshots of the available Future Spreads and noted two statistics. The first statistic is how many of the spreads are quoted a single tick wide*, and the second statistic is for any Future Spreads that were quoted wider than one tick, what was the largest difference between the bid and ask as a percentage of the index price.

*Currently one tick is $0.50 for BTC, and $0.05 for ETH. Being quoted one tick wide means that the difference between the bid price and the ask price is as small as possible.

These were the results:

1st August 2023 at approximately 21:00
BTC

• 22/28 order books quoted one tick wide
• Largest bid/ask spread: 0.094% of index

ETH

• 26/28 order books quoted one tick wide
• Largest bid/ask spread: 0.032% of index

2nd August 2023 at approximately 13:00

BTC

• 23/28 order books quoted one tick wide
• Largest bid/ask spread: 0.024% of index

ETH

• 28/28 order books quoted one tick wide
• All spreads were only one tick wide

As we can see, the majority of the Future Spreads for both BTC and ETH are being quoted only one tick wide, and on the second snapshot 100% of the ETH Future Spreads were quoted as tightly as they possibly can be. It’s also worth noting that the resting quote sizes are typically well over $100,000 on both sides, giving traders the possibility to fill orders in either direction immediately.

Who benefits from this great double sided liquidity?

Obviously anyone wanting to speculate on the spread between two futures contracts will enjoy being able to move in and out of their positions with such ease. The combination of tight bid/ask spreads, good sized quotes, and the fee discount for trading the two futures by using a single Future Spread order book, will help to keep trading costs like slippage and fees to a minimum.

Traders speculating on the spreads themselves aren’t the only ones who benefit from this liquidity though. It is also possible to use the Future Spreads to roll a position from one future contract to another. Using the single Future Spread order book can be much more efficient than doing the same trade of buying one future and selling another in each of the individual orderbooks.

Traders rolling positions would include:

• Option traders who maintain a delta hedge on a futures contract. They may execute the initial hedge on the perpetual to get access to the largest liquidity for example, but then wish to roll that perpetual position to the dated future contract that matches the option position they are hedging.
• Cash and carry traders who want to roll their position out to the next expiry to capture some more premium.

Notice in both of these examples that the traders only have a position on one future contract at a time. They are simply using the Future Spread order book to move their position from one contract to another. This highlights how it is not necessary to be holding opposing positions on two different futures contracts for the Future Spreads to be useful.

Other benefits of Future Spreads

As we have covered, by using a Future Spread instead of executing two separate trades in the individual order books for the two different future contracts, traders get the benefit of impressive double sided liquidity. However, they also benefit from having no leg risk (both legs are executed at once), a known price for the combination of both legs, and not having to monitor and manage orders in two order books until they are both filled.

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The Price Ladder on Deribit is an alternative way to place and edit orders. A price ladder, also sometimes known as depth of book, depth of market, or trade ladder, is typically used by professional traders who are trading very actively.

The Price Ladder allows for single click order placement and cancellation by clicking on the price levels in the ladder. This means traders can place multiple orders quickly while having a good view of the surrounding price levels. For traders who are comfortable with it, the Price Ladder may completely replace the regular order form as their preferred method of order entry.

In this tutorial, we will walk through how the price ladder component works, highlighting the features as we go. And of course we will show some examples of placing and cancelling orders.

Order quantity currency

The first toggle in the top left is a currency selection. This allows us to set the values of our order in either USD or BTC in this case as we are trading the bitcoin perpetual. As we are trading the inverse perpetual, the order sizes will actually be in multiples of $10, but we can still enter our sizes in BTC if we prefer, and the size of the orders submitted will be rounded to the nearest multiple of $10.

Instrument search

The instrument bar allows us to select the instrument we want to place orders on. It’s possible to place more than one Price Ladder component on the page, and choose a different instrument for each.

Order type and settings

You will recognise the next collection of settings from the regular Deribit order forms. Here we can choose the order type, time in force, reduce, hidden, and post. Each of these order settings works the same as they do on the standard trading pages on Deribit, and we can use these settings to choose what type of orders will be placed when we click in the Price Ladder.

Mark/index

Shows the mark price and index price of the selected instrument.

Open position size

When we have an open position, it is displayed on the left, above the order size settings.

Amount (of next order)

As we will see shortly, we place orders with a single click in the price ladder, so we need to know the size of the orders we are going to place. The ‘Amount’ field shows what size the next order that is placed will be. To edit this we can either manually enter it, or we can edit it using the preset buttons underneath.

Presets

When we click one of the preset size buttons, it will add that amount to the amount of the next order. For example, if we currently have an order amount of 10 entered, and then click the preset button with 20 on it, 20 will be added to the order amount, making it 30. This means the next time we place an order, the quantity of that order will be $30. If we want to add another 20 to make the next order amount 50, we simply click the same button again.

We can edit the value of each preset, and the value of the default amount, by clicking ‘Edit Presets’.

Whenever we place an order, the ‘Amount’ field will then revert back to whatever value we have set as the Default Amount here. We can also edit the values of each of the five preset buttons.

Reset

The reset button resets the Amount field back to the Default Amount. So if we have clicked some preset buttons to increase the size of the next order, but then we change our minds, we can click reset to reduce the amount back to the default.

Column overview

In the Price Ladder itself, we have a Price column in the centre. This shows each of the possible price levels orders can be set at. Either side of this are the Bids and Asks columns, which show the total size of the orders from all users currently placed on those levels.

The Buys column shows the size of any of our own orders to buy. The Asks column shows the size of any of our own orders to sell.

Placing a buy order

To place an order to buy, we click in the Bids column.

In this example, we have the Limit order type selected, and an Amount of 10. So when we click in the Bids column at the price level of 29215.5, a limit order to buy $10 of the BTC-PERPETUAL is placed at a price of $29,215.50.

Placing a sell order

To place an order to sell, we click in the Asks column.

To place multiple orders we can click multiple times, and this can be on different price levels, or the same price levels multiple times. Here we’ve placed a total of seven orders with a quantity of 10, and some of these orders have been placed at the same price levels. This results in a total quantity of 20 showing in the Sells column (which shows all of our orders to sell).

Cancelling orders

Sometimes we will want to cancel an order, or multiple orders, and there are several ways to do this.

We can click the order in the Sells column (or Buys column for our bids). This will cancel the most recently placed order at that price level. This has the benefit of the oldest orders retaining their queue position. Clicking in the Buys or Sells column only cancels one order at a time, so if we have multiple orders on a price level, we would need to click multiple times to cancel all the orders on that level.

If we want to cancel all of our orders to sell in a single click, we can do so by clicking Cancel Sells in the bottom left. Similarly we can click Cancel Buys to cancel all of our orders to Buy at once. Or if we want to cancel all of our buy and sell orders in a single click, we can click Cancel All.

Moving orders

If instead of cancelling an order we want to move it, instead of clicking the order, we need to click, hold and drag the order in the Buys or Sells column. When we let go, the order will be moved to the new price level.

Price grouping

By default, the price ladder does not use price grouping, and so every available price level is shown. However, some traders may not need that amount of detail, and instead they may want to see a wider price range. This can be achieved by using price grouping, which can be accessed by clicking the title of the Price column.

Centering the market

When the price ladder is first loaded, the current underlying price will be in the centre. There will be asks at the top in red, and bids at the bottom in green. The price levels will stay where they are though, so as the underlying price moves up or down, the underlying price may move off the screen.

This keeps the price levels stable on the screen, but of course we will often want to move the new current price to the centre of the ladder again, so we can see where the current trading action is.

There is more than one way to do this. The simplest way is to right click anywhere in the price column. This will bring the current price to the centre of the ladder, until the price moves again.

Another way of achieving this is to click either the ‘Centre market’ or ‘Centre all markets’ button. The ‘Centre market’ button will centre only the Price Ladder where the button is clicked. The ‘Centre all markets’ button will centre all Price Ladder components on the page.

If we want to keep the ladder centred at all times, we can use the ‘Lock’ to lock the market at the centre. This will keep the current price in the middle of the ladder.

Font size

Finally, to the right of the centring options, it is possible to choose the font size of the values in the price ladder. This allows us to customise the view of the ladder to suit the screen we are using.

Testing the Price Ladder

As the Price Ladder allows single click trading without an order confirmation popup, if you are new to the Price Ladder, you may wish to try it out on testnet first. This will allow you to place orders, test all the features, and get comfortable with the controls, without risking any funds. Testing can be done at test.deribit.com.

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The two statistics Implied Volatility Rank (a.k.a. IV Rank, or IVR) and Implied Volatility Percentile (a.k.a. IV Percentile, or IVP) both measure how the current level of implied volatility (IV) compares to the historical range of values for IV. It’s possible to calculate these statistics for any period of time, but it’s most common to use the range of values over the previous year.

IVR ranks the current IV against the historical range of IV over the last year, and IVP shows what percentage of time the IV was lower than the current level over the last year. Both measures give a value between 0 and 100. We’ll get into how each differs soon, but for both IVR and IVP, a value of 0 means IV is very low compared to normal, and a value of 100 means IV is very high compared to normal. With ‘normal’ here simply meaning the range of values over the last year.

As IV tells us how cheap or expensive options are, both IVR and IVP can be used to gauge how cheap or expensive options currently are, compared to typical values for each underlying.

IVR and IVP give context to IV

IV allows for better price comparison between different options. This is because it takes into account the factors that affect how much an option is worth, like time and moneyness*. This allows each option price to be stated as an annualised volatility figure.

*Moneyness = where the strike price is relative to the current underlying price.

IVR and IVP give further context to this by allowing for better comparison to historical norms for the underlying.

For example, even if you have traded options before, if you were new to trading cryptocurrency options specifically, you might not be familiar with what typical implied volatility figures are for bitcoin or ethereum. If the IV for bitcoin is sitting at 45%, is that high or low? 45% IV would be high for something like US Equity index the S&P 500, but it would have been low for the meme stocks like Gamestop or AMC that became popular amongst retail option traders in 2021. We need to give some context to the IV figure.

IVR and IVP give us this context by comparing the current IV for an asset to historical values of IV for that same asset. Each statistic simplifies this comparison down to a single value between 0 and 100, with each one telling us something slightly different.

Calculation methods

Thankfully the calculations are relatively simple. All we need is the historical data for IV, and for that we will use the DVOL index data.

Information on DVOL can be found here.

IVR tells us how far into the historical range of IV the current value of IV is, and is calculated as:

Current IV – IV Low / IV High – IV Low * 100

Where:

Current IV = the current level of implied volatility.
IV Low = the lowest value that implied volatility has been for the underlying in the last year.
IV High = the highest value that implied volatility has been for the underlying in the last year.

(All as measured by DVOL)

IVP tells us what percentage of the time IV has been below the current value of IV, and is calculated as:

Periods Lower / Total Periods * 100

Where:

Periods Lower = the number of periods in the last year that implied volatility has been lower than the current level.
Total Periods = the total number of periods in the last year. E.g. if the period is 1 day, the total number of periods is 365.

The only data that is required to calculate both of these statistics is the last year of historical data for the DVOL index.

Why show both IVR and IVP?

Both statistics are showing a different version of the same thing, as they both show how current IV compares to IV over the last year for the underlying we are looking at. However, it is still useful to see both due to the differences in how they behave with certain data.

IVR is more sensitive to outlier values. A single occurrence of dramatically higher IV could lead to relatively lower values of IVR for a long time, until that single data point has fallen out of the comparison period (usually one year). IVP does not suffer from this because it’s not looking at the full range of values, and only measures how much time is spent below the current level of IV, so a single day’s IV value only counts 1/365th towards the IVP value.

IVP can be overly sensitive to small changes in IV though, depending on where current IV is relative to the distribution of the previous values. Whereas IVR deals with the scale of moves in IV more consistently. A small change in IV will typically mean a small change in IVR.

An example of how IVR and IVP can differ

Imagine the current IV is 60, and we have the following 10 historical readings for IV.

[100, 50, 70, 59, 50, 50, 50, 50, 50, 50]

IVR here would give us a reading of just 20, because the value of 60 sits 20% of the way into the range of 50 to 100.

Current IV – IV Low / IV High – IV Low * 100
= 60 – 50 / 100 – 50 * 100
= 20

This makes it seem like IV is quite low compared to usual. However, the current level of 60 is higher than most of the previous readings.

Let’s see if IVP gives us any more information. IVP is calculated as:

Periods Lower / Total Periods * 100
= 8 / 10 * 100
= 80

A very different impression is given by the IVP here. It’s telling us that the IV has been lower than the current value of 60 for 80% of the time.

Together, these two statistics tell us that although IV has been quite a bit higher than the current level of 60 at some point in the past, it has spent the majority (80%) of the time below this level.

Usually, the two statistics won’t be as far apart as they were in this contrived example, and they will typically be telling us a similar story. For example, if they are both over 90, we can be confident that IV is higher than normal. If they are both below 10, we can be confident that IV is lower than normal. If they do ever diverge though, we can look at the DVOL chart to see why.

Continuing with this example

Let’s say that we move forward one time period. We are still only going to use the 10 previous readings for comparison, so our historical values are now:

[50, 70, 59, 50, 50, 50, 50, 50, 50, 60]

Note that the previous high value of 100 has dropped out of the dataset.

Let’s also assume that our current reading for IV is 61. This is just one point higher than our previous value of 60, so IV has barely moved. How has this affected our readings for IVR and IVP?

IVR = 61 – 50 / 70 – 50 * 100 = 55
IVP = = 9 / 10 * 100 = 90

The IVR has moved from 20 to 55, and the IVP has moved from 80 to 90. IV did increase very slightly from 60 to 61, so it’s not surprising to see these two statistics increase. However, we can now see what a dramatic impact that one data point that dropped out of the dataset was having on the IVR. The range changed from 50-100 to 50-70. So despite the relatively small increase in IV, the IVR increased dramatically, whereas the IVP increased by a much smaller amount.

Finally, imagine we move forward one more time period, so our historical values are now:

[70, 59, 50, 50, 50, 50, 50, 50, 60, 61]

Let’s assume that our current reading for IV is now 58. This is just three points lower than our previous value of 61. How has this affected our readings for IVR and IVP?

IVR = 58 – 50 / 70 -50 * 100 = 40
IVP = = 6 / 10 * 100 = 60

IV has decreased, so it’s not surprising to see both values decrease. IVR moved from 55 to 40 (a decrease of 15), but IVP moved from 90 to 60 (a decrease of 30). This move in IVP would seem to exaggerate the relatively small move of 3 points in IV. This occurs because an increasing number of the data points are close to the current IV level. So as the current IV moves either side of this cluster of values, there is a larger percentage of the values that become either over or under the current level.

With this example, we’ve covered how to calculate each statistic, as well as what circumstances can lead to oversized moves in each. We have seen that IVR can change dramatically solely because one extreme data point has fallen out of the comparison period. And we have seen that IVP can change dramatically even when IV has only changed by a relatively small amount. This occurs when a lot of the previous data points are clustered close to the current IV.

So, just long relatively low IV, and short relatively high IV, right?

Well, although volatility is mean reverting over the long term, it tends to cluster in the short term. This means it can maintain extreme values over the short term. Just because IV is very low, with IVR and IVP both showing values of less than 5, doesn’t mean that IV won’t continue to be low for several weeks, or even months.

It’s also worth bearing in mind that even if IVR and IVP are both sitting at the maximum value of 100, that doesn’t mean volatility can’t increase even further. The reading of 100 simply means that IV is the highest it’s been in the measurement period (usually 1 year). However, it can still increase further, setting a new record high, and keeping the IVR and IVP values pinned at 100 until IV finally falls away from the new high.

Similarly, when IVR and IVP are both at the minimum value of 0, volatility can still decrease further.

So, although extreme readings may tilt the odds in favour of mean reversion, there is no guarantee.

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