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Bybit Learn
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Jul 12, 2022

Volatility

Volatility is the tendency to change quickly and unpredictably. The word is often used in reference to securities or crypto assets and their price changes.

What Is Volatility?

Volatility is a statistical measurement used to determine the return dispersion of a market index or security. The variance or standard deviation between a market index and a security can be used to determine volatility. 

With securities or crypto assets, higher volatility is associated with greater risk. This is because the asset proves that it can change price dramatically in a short period of time. If an asset has lower volatility, investors know that it has a tendency to be more predictable. 

When people talk about volatility in crypto or stocks, they’re usually referring to significant swings in one direction that exceed 1% for a sustained period. The volatility of an asset is a key consideration for investors in securities or crypto. Volatility periods may be measured in annual, monthly, weekly or daily structures. Market volatility may be influenced by economic shifts, political factors, industry changes and company factors.

How Is Volatility Calculated?

First, determine how many numbers or values are in the data set. 

Next, find the mean of the data set. The mean is the average of all the numbers, which is obtained by adding them together and dividing by the total number of values in the data set. 

The next step is finding the deviation. To do this, calculate the differences between each value and the mean. Note that negative numbers in the set can also be included. 

After finding all of the differences, square the deviations to remove any negative values. 

Next, add all of the squared deviations, and divide that total by the number of values in the set.

Measures of Volatility

There are several measures of asset or market volatility. The following are some of the common measures used today.

Implied Volatility

Implied volatility is an important factor in options price setting. Options are derivative contracts which give buyers the right to sell or buy underlying assets at set prices, before or on a certain date. However, the owner is not obligated to buy or sell. 

The options market has an offer and bid system, like an auction. Sellers and buyers conduct trades and initiate price discovery. The Black-Scholes formula may be used to calculate implied volatility, which is implicit from the bid and offer, or from a traded price. Unlike historical volatility, implied volatility varies for an asset depending on options strike prices. These variations are referred to as volatility skews.

Historical Volatility

Historical volatility is an annualized one standard deviation (1 SD) of prices that shows the deviation of past prices from the historic price or average for a certain period. This is an important measure, since it helps people better understand the entire concept of volatility. Uncertainties, market corrections and other factors can shift volatility higher. When these factors aren’t occurring, measurements show that there’s a lower shift or a decline.

Intraday Volatility

Although other measures focus more on longer terms, intraday volatility focuses on the ups and downs within trading sessions. It’s the measure of an asset’s volatility between the opening and closing of trading sessions. Day traders are especially interested in intraday insights, while traditional investors tend to be more interested in long-term measures.

Volatility Index

The Volatility Index (VIX) is a real-time representation of market expectations for the S&P 500's implied volatility. The index is also commonly referred to as the Market Fear Index (or “Fear & Greed Index”). Due to the near-term expiration date prices from which it’s derived, the index shows 30-day predictions. Cboe Global Markets created and maintains the index, which, with its quantifiable market risk calculations, is a critical tool in securities trading.

Crypto Volatility Index

The Crypto Volatility Index, or CVI, is a decentralized benchmark. Its purpose is to track crypto market and options price volatility. This index was developed by a project called COTI, whose team launched the CVI in 2021 on Ethereum's mainnet. The index computes its decentralized volatility index from market expectation analysis, crypto options prices and future projections.

Think of the CVI as a crypto version of the VIX. It gives DeFi users the ability to profit from or hedge against crypto market volatility. Like the VIX, the CVI includes real-time updates and forward projections for 30-day periods. This index uses theoretical values or fair prices for a put or a call, using six variables. These variables include option type, volatility, underlying stock price, strike price, time and risk-free rate. Numbers on the CVI fluctuate up to 200. Many crypto traders today use the CVI as a way to determine risk.

Ways To Reduce Crypto Volatility

There are some ways to potentially reduce crypto volatility. Smart money management, stablecoins and future considerations are a few strategies.

Managing Money

Many advisers recommend that crypto investors avoid holding large amounts of a currency in a single market. When they hold a large amount in one market, it can create a sudden impact on capital. Investors can benefit from spreading their investments across different crypto assets, or partially in traditional securities as well.

Stablecoins

By design, stablecoins can help improve market stability and reduce fluctuations. Stablecoins relate to fiat currency value, which means that exchanging fiat into crypto doesn’t come with fluctuations. Also, traders can make transfers more easily with stablecoins.

Future Considerations

Taking future financial derivatives into consideration can introduce alternatives for future contracts of a currency, in addition to demonstrating a currency’s potential. Some exchanges offer hedge solutions to customers to help protect them from the effects of negative price changes.

Understanding the broader concept of volatility can help crypto investors appreciate the value of the CVI, and to understand how to use volatility information in making decisions. Because crypto volatility is influenced by numerous factors, understanding it is important for both new and seasoned crypto traders.