Haoski

Derivative Structurer at OnTrade.com

Building the first tradable Bitcoin Volatility Index (VIX) futures

A volatility index or VIX, is used to measure the expected volatility of the underlying within a timeframe in the future, there are at least two ways of calculating implied future volatility, the most widely used method is the one employed by CBOE’s VIX calculation, the one which is “modeless”.
Here’s an extraction from CBOE’s VIX white paper, highlighting their methodology.
Or, one can use the Black-Scholes equation to reverse calculate implied volatility given the best bid-ask price of publicly listed options.
Currently, only LegerX tracks the volatility index on Bitcoin. They used the method same as CBOE and uses data on their own — thinly traded — option order book.
Besides LegerX, we are the only other one in the market tracking Volatility Indexes and we built tradable futures on the VIX as well.
we used the Black-Scholes-model based method when constructing the VIX on bitcoin, we calculated implied volatility by inputting the mid-price of options as theoretical price and got implied volatility. Below is our calculation method.

Here are some details about our modeling choices:

First, All of our options data is streamed from Deribit and Deribit only, as they are the only marketplace with valid option pricing and just enough liquidity.
We used the two strikes that are closest to at-the-money and reverse calculated volatility for those strikes.
If for the moment there are not any quotations on the strikes of choice, we will take the next out of money strike level until both bid and ask prices are present.
Our VIX is tracking the strikes of the most traded expiry on Deribit, that being the Biweekly and the monthly expiry. Deribit weekly options expire on every Friday 4 PM UTC+8:00, we will do index expiry rolling on every Friday 4:45 PM UTC+8:00, giving a 45 minutes window so the market makers will have enough time to establish quoting for newly listed options. Hence the VIX constructed measures roughly the annualized at-the-money volatility of 14 natural days.
OnTrade listed Daily, Weekly, Biweekly and Quarterly Futures on Bitcoin VIX, the expiry of future will take TWAP of 1 hour of Volatility Index, which is different from how CBOE calculates the settlement prices. Unrealized PnL and forced liquidation are determined by the newest Future’s price versus average entry price.
we are considering the best method of settlement calculation and reserve the right to change to a better and fairer method in the future. We are also considering listing perpetual swaps on VIX given the continuous nature of the crypto market. we are in the process of switching to Fair-price based marking.
We will also halt trading if for any reason Deribit is offline and resume trading when they are online again, it is to reduce the chances that the prices are being maliciously manipulated.
There are several reasons for our construction choice:
Bitcoins’ options market is very illiquid, Using CBOE’s construction method will make the index very… jumpy. Because CBOE’s method takes option prices of all quoted out-of-money strikes into account, in a thinly traded market, there are only limited numbers of strikes, the price differences between strikes are large, Market Makers will also frequently on-off quoting far out of the money strikes, making heavy impacts on VIX calculation.
Secondly, Deribit can insert strikes within an expiry unannounced. For the brief moment afterward, there will not be any option price on the new strikes, and thus the VIX calculation will be heavily impacted if we follow CBOE’s method without any tinkering.
But there are also shortcomings.
First of all, implied vols at the tails are not accounted for thus the calculated value from such method will underestimate true value, but, it will track the change in the volatility very precisely.
It will neither be a perfect Vega hedge due to the reason above, yet given that most tradings are around the at-the-money level, it is the best proximation with a smooth index price.
With all being said, Below is a screenshot from the live trading environment, Above is the volatility index and below is the BTC quarterly futures. Notice how Implied Vol reacted during the two Bart Simpson patterns on 17th and 19th.
Above picture shows VIX index level since 14th Sep till 21st Sep, With 1 hour Kline plotted. edited from the original for better illustration.Bitcoin futures price within the same time period

About me and OnTrade:

Click my Referral to have a look at our new exchange.
you can call me Haoski. Derivative designer @ontrade.com I worked as a trader and a quant in Amsterdam…I am also an avid researcher of crypto-economics and quantitative models, you can check my previous stories here https://medium.com/@howlyang
Currently, we are (relatively) unknown and unheard of, there is an enduring journey ahead of us and our rivals are..prodigious. But we will have a heavy focus on innovative products and a design philosophy inspired by the true utility of derivatives, to hedge risk instead of high-leverage-high-risk gambling toys.
we are sufficiently funded for years to come, Raise together with us.

References:

Brenner, M. and Galai, D., 1989. New financial instruments for hedge changes in volatility. Financial Analysts Journal, 45(4), pp.61–65.
CBOE VIX White Paper. Retrieved 2019–09–20

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