Volatility Indices. The market's forecast of its own movement.
A volatility index distils options prices into a single number representing how much movement the market expects over a coming window. Deribit's DVOL is the best known in crypto, playing a similar role to the VIX in equities.
Because it is forward-looking, it is one of the few readings that is not simply a restatement of what price has already done.
Implied is a forecast, realised is the outcome
Implied volatility is what options buyers are paying for expected movement. Realised volatility is what actually occurred. Implied usually sits above realised, because people pay a premium for protection, and the gap between them is itself a tradeable quantity. When implied collapses below realised, the market is underpricing movement it is currently experiencing.
Volatility Indices in a strategy
Scaling size inversely to expected volatility keeps risk per trade roughly constant across regimes.
A strategy can require a volatility band, running breakout logic in expansion and range logic in compression.
Sustained low implied volatility often precedes large moves, without indicating direction.
Near-dated implied rising above longer-dated signals expected near-term stress.
Size positions inversely to expected volatility
Not an entry signal. A sizing rule that keeps the risk of each trade stable instead of letting it swing with conditions.
- IFRead current implied volatility and compare it to its own 90-day median
- ANDIf implied is above the median, scale position size down proportionally
- ANDIf implied is below the median, allow full size, capped at your normal maximum
- ANDNever let the adjustment increase size beyond the standard limit
A fixed position size means your actual risk doubles when volatility doubles, which is how accounts get hurt in exactly the conditions that demand caution. Scaling by expected rather than past volatility responds before the movement rather than after. The cap on the upside is deliberate: the rule should only ever reduce risk, because leveraging up into calm markets is how quiet periods become expensive ones.
The most established crypto volatility index, published for BTC and ETH and derived from Deribit's options book.
Several data providers compute their own implied volatility measures from listed options across venues.
Computed directly from the price history you already have, with no third-party data required.
Coverage is thin outside BTC and ETH
Crypto options markets are concentrated in a couple of assets and a small number of venues, so a volatility index for anything else is either unavailable or derived from a book too thin to trust. Realised volatility is the more practical substitute for most assets.
Wire Volatility Indices into a live strategy.
Paper trade it first, go live when the numbers convince you.
- Position sizing
- Regime switching
- Compression before expansion