Volatility surface arbitrage refers to the strategy of exploiting pricing discrepancies across the implied volatilities of options with different strike prices and maturities, which collectively form the volatility surface. In crypto, this involves identifying and profiting from mispricings in the implied volatility of institutional options on digital assets.
Mechanism
The volatility surface is a three-dimensional plot where implied volatility is shown as a function of both strike price, known as the “volatility smile,” and time to expiration, referred to as the “term structure.” Arbitrageurs detect instances where the implied volatilities derived from market option prices deviate from theoretical values or from other options on the same underlying asset. This allows for risk-neutral profit by simultaneously buying undervalued options and selling overvalued ones.
Methodology
This advanced methodology requires sophisticated quantitative models and real-time data analysis to continuously monitor the crypto options market for pricing inconsistencies. Strategies involve constructing portfolios of options and their underlying spot assets that are delta-neutral and gamma-neutral, aiming to profit from the mean reversion or correction of the mispriced implied volatilities. The objective is to capitalize on transient market inefficiencies, ensuring the theoretical consistency of option prices across the entire volatility surface.
Dynamic capital allocation leverages real-time quote data to optimize capital deployment, mitigate risk, and enhance execution quality through algorithmic precision.
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