How Does ‘Implied Volatility’ Differ from ‘Realized Volatility’ and How Can This Spread Be Arbitraged?
Implied volatility (IV) is the market's forecast of future price choppiness, derived from an option's price. Realized volatility (or historical volatility) is the actual price movement that occurs over a period.
Arbitrage opportunities arise when there's a significant spread between IV and what a trader expects the realized volatility to be. If a trader believes IV is too high, they can sell options (like a straddle or strangle) to collect the premium, betting that the actual price movement will be less than the market implies, thus profiting from the decay of the option's value.
Glossar
Realized Volatility
Calculation ⎊ Realized volatility, within cryptocurrency markets and derivatives, represents an empirical measure of price fluctuation over a specified period, contrasting with implied volatility derived from option pricing models.
Actual Price Movement
Action ⎊ The quantifiable change in an asset's market price over a specified time interval.
Implied Volatility
Expectation ⎊ This value represents the market's consensus forecast of future asset price fluctuation, derived by reversing option pricing models using current market premiums.