Explain the Concept of “Stochastic Volatility” and Why It Is Preferred for Crypto Options

Stochastic volatility models, such as the Heston model, assume that the volatility of the underlying asset is not constant (as in Black-Scholes) but rather a random variable that changes over time. This approach is preferred for pricing crypto options because it better captures the empirical features of cryptocurrency markets, such as volatility clustering (periods of high volatility followed by more high volatility) and the volatility smile/skew.

By allowing volatility itself to be modeled as a dynamic process, it provides a more accurate theoretical price for options in highly volatile and jump-prone markets.