Crypto Volatility trading

What is volatility trading?
Volatility trading differs from directional trading in that you don’t take a position on the direction of the asset price. You don’t bet that the price will increase or fall, instead you bet on the volatility. If you believe that volatility will surge, you go long volatility anticipating big moves. Conversely, if you think the market will not experience large swings, you short volatility.
As a relatively new asset class, cryptocurrencies are very volatile which creates opportunities for those who can exploit them. In this article, I will describe several trading strategies that can be used to benefit from big price movements in the crypto market. Some of them are pretty simple while others require sophisticated skills and a deep understanding of volatility.
 
Strategies
Ranged Markets on Thales
The easiest way to trade crypto volatility I can imagine is the Ranged Markets on the Thales protocol. Ranged Markets revolve around the price range, not the specific strike price. Traders bet on if the specific asset price will fall in the given range at the maturity date. A real example of the Ranged Market as of this writing: Asset – BTC, strike prices - $16,500 and $20,500, Maturity date – Oct 7, 2022.
Each Ranged Market is defined by these variables:

• It’s self-explanatory – the asset on which the participants make bets.
• Strike range. Price range between the two price levels the participants bet on
• The settlement date of the Ranged Market.

Traders participating in Ranged Markets IN and OUT tokens. If in the example above, you believe that BTC price will end up in the given range of $16,500 - $20,500 at the maturity date, you want to buy IN tokens. If you think that BTC price will be below $20,500 or above $18,500 at the expiry date, you can buy OUT tokens.
Let’s say, you buy 1,000 OUT tokens for 567.8 USDC (an OUT token for this market is traded at 0.5678 USDC at the time of this writing). If on 7th October the Bitcoin price falls outside of the range of $16,500 – 20,500, your investment will be worth 1,000 USDC. That is 76.1% return on investment in two weeks!
You can think of the Ranged Markets concept as volatility trading. If you expect that volatility will increase, you should buy OUT tokens; it’s like going long volatility. Conversely, if you expect that volatility will drop, you can buy IN tokens; it’s like going short volatility.
 
Crypto Volatility Index
Another way to express volatility trading in the crypto market could be Crypto Volatility Index, or CVI. Created by COTI team, CVI Index measures the expected volatility of the crypto market based on the cryptocurrency option prices. It is calculated based on 30-day prices of options traded on exchanges.
CVI index can be traded for hedging purposes especially if one expects big moves in the market. During such events the crypto market can be highly volatile. The sharp spikes on the chart below support the notion that sometimes crypto traders may experience wild swings which is what happened in the beginning of Coronavirus crash. The highest value of CVI was 158.4 on 17 May 2021 when Tesla CEO Elon Musk tweeted that the carmaker company may stop taking Bitcoin as payment due to environmental concerns. As a result, Bitcoin lost 27% of its value in that week which drove the whole crypto market down.
 
Another idea might be shorting the index after a big spike. As you can see, volatility tends to drop after a significant increase. One can exploit this mean-reverting tendency of volatility by shorting it after a sharp surge.
 
Momentum trading
What momentum means is buying recent winners and shorting recent losers. There is an extensive research covering almost all asset classes that momentum works. An idea as simple as going long assets performing well in the recent past and going short those that performed poorly seems to work.
We can apply momentum strategy to cryptoassets to verify if it can be exploited in this asset class too. To do it we should quantify the idea first. Statements such as “recent past”, “good/bad performance” in the explanation of momentum strategy in the paragraph above are a bit vague. When researchers backtest momentum strategy in equity markets, they usually look back to 3-12 last months’ performance dropping the last month. And the holding period (how long you’ll hold an asset) is typically 3-6 months.
However, DeFi is more dynamic, fast-paced and volatile than traditional asset classes, such as equities and bonds. Therefore, I modified parameters as following: 49 days of lookback window (how many last days’ data we will look at) ignoring last 14 days data and holding period of 7 days. The strategy works step-by-step as follows: first, I make a list of more than 100 tokens that trade on Binance. Then, for each of these tokens, I compare their yesterday settlement price and settlement price 45 days ago which gives us the performance over 45-day period.
As the next step, during a week (since our holding period 7 days, we rebalance our portfolio weekly) I sort coins’ returns and select 5 coins with the highest recent performance. Even this simple strategy gives us 0.69% weekly return. The number may seem small but it means a 43% annual return which is high for such a simple strategy. And consider that we haven’t optimized, improved or modified the strategy. It’s possible to add some conditions which would make it less likely for the strategy to trade in bear market. From the chart we can see that the last 12-13 weeks the strategy performed poorly since overall crypto market was and remains bearish at the moment.