The Bitcoin Volatility Index’s correlation with the Bitcoin price turns positive, increasing the appeal of bullish call options

Crypto options exchange Deribit’s forward-looking bitcoin volatility index (DVOL) provides clues about the market’s expectations for price turbulence over the next 30 days, just as CBOE’s volatility index, the VIX, does for stocks.

An important difference has emerged this year. While the VIX continues to serve as Wall Street’s fear gauge, rising during bouts of risk aversion, the DVOL has developed a positive correlation with the cryptocurrency’s price. The 30-day correlation coefficient between bitcoin’s price and the DVOL index turned positive in early January, rising to a peak of 0.85 last week. At press time, the coefficient was 0.72. That has made call options linked to bitcoin more attractive than ever, according to observers.

“Since the start of 2023, bitcoin has shown a strong spot/implied volatility regime with positive correlation. It has turned 2022 on its head,” Greg Magadini, director of derivatives and crypto data provider Amberdata, told CoinDesk. “It has rewarded call buyers with directional spot gains and increasing volatility gains.”

Introduced in early 2021, DVOL measures bitcoin’s 30-day implied or expected volatility using Deribit’s options order book. The VIX is based on the option prices of the S&P 500 stock index.

Options are derivative contracts that give the buyer the right, but not the obligation, to buy or sell the underlying asset at a predetermined price on or before a specific date. A call option gives the right to buy, a signal the holder has a bullish attitude, while a put option gives the right to sell. Option prices are determined by several factors, including market direction as well as implied volatility, which is affected by the supply and demand for options.

DVOL’s positive correlation with the cryptocurrency’s price means call options can benefit from both favorable directional movement and an increase in implied volatility. In other words, calls are likely to see faster price appreciation during bullish moves than puts during bearish moves.

“Assuming the spot/vol correlation persists, this increases the appeal of owning calls as a call buyer can hit a ‘double whammy’ and win on both Delta [directional gains] and Vega [implied volatility gains] in a strong rising market,” Spencer Hallarn, an OTC trader at crypto trading firm and liquidity provider GSR, told CoinDesk.

The positive correlation is in stark contrast to last year, when bitcoin’s downward swing after an 18-month bullish trend caught traders off guard, leading to panic buying of put options. At that time, DVOL increased during notable price declines, and the puts saw a faster price increase during bearish price action than calls during corrective rallies.

CBOE’s VIX index rises during bearish market environments and falls or remains stable when the market rises. That’s because stock traders tend to be long-term bullish and are quick to pick up offers for protection at the first sign of weakness in the stock market. The demand for protection disappears when the market rises, leading to a decline in the VIX. The net effect is that puts see a faster increase in value during market failure than calls do during risk trends.

Bitcoin rose almost 70% in the first three months of the year, defying expectations of a continued market decline. According to OTC technology platform Paradigm, funds have been piling up to upside or bullish traders via options.

The fear of missing out, or FOMO, may soon kick in, driving stronger demand for alternatives and pushing DVOL higher.

“The crypto market can sometimes rise and everyone will then be fully into it (FOMO, especially since we came down from the $68K level),” said Pierino Ursone, head of options at Deribit, while explaining DVOL’s positive correlation with price . “When additional demand for ‘out-of-the-money’ higher strike calls starts for crypto, beware that it can be very strong and persistent.”