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Calculating Ethereum's implied volatility
What is implied volatility and how does it help with predicting the future price of Ethereum?
Crypto-technical analysts point to volatility as an indicator of a potential bottom, but how? Implied volatility (IV) is at a 2-year low. We see BTC at-the-money IV at ~30% vs its May 2021 high of ~150%….
… and Ethereum’s ATM IV at ~62% vs its May 2021 high of ~220%.
But what does this actually mean? How is an IV of 62% “better” than an IV of 220%? Technical analysts like to use IV to measure stability and potential bottoms because it represents the “potential price range of an asset”. More specifically,
IV is expressed as a % of the crypto price
It is the predicted one standard deviation move over a 365-day period
If you don’t remember anything from your statistics class, this means:
Ethereum’s price should end up within one standard deviation of its current spot price 68% of the time in the upcoming 12 months
Ethereum’s price should end up within two standard deviations of its current spot price 95% of the time in the upcoming 12 months
Ethereum’s price should end up within three standard deviations of its current spot price 99% of the time in the upcoming 12 months
Using ETH’s current spot price of $1,500 and IV of ~60% and focusing on one standard deviation of movement, the consensus in the “marketplace” is that there is a 68% chance that at the end of one year ETH the asset will be priced somewhere between $930 and $2,430.
By extension, this also means there is only a 32% chance that ETH will be outside of this range. There is a 16% probability that ETH will be above $2,430 12 months from now, and a 16% probability that ETH will be below $930 12 months from now.
Technical analysts point to knowing the probability of an underlying asset within a certain range as an important indicator when determining what options to buy or sell.
When the IV on ETH was 220% on 5/21, its spot price was $4,100. This implies that the market believes with 68% confidence that ETH will trade between an upper bound of $13,120 and a lower bound of -$4,920. Not so useful right? At best we can extrapolate at times of peak volatility, marketplace consensus is uncertain.
To knowledge and wisdom,
Article cover generated by DALL-E: “A Van Gogh style painting of mathematicians using an abacus to predict the future price of Ethereum”