Trading term

What is Volatility risk premium?

The volatility risk premium is the gap between the volatility the options market prices in (implied) and the volatility that actually happens afterwards (realised). It is usually positive: buyers pay for more movement than they get, on average, because they are paying for protection against the rare day when movement is extreme. It is what option sellers collect and what option buyers give up.

Implied volatility is a forecast and realised volatility is the outcome, so the two can be compared after the fact. Across most markets and most years, implied runs above realised — on bitcoin, for example, Deribit's DVOL has exceeded the volatility of the following thirty days on roughly seven days in ten, by a median of about ten points. That persistent gap is the volatility risk premium, and it exists for the same reason insurance premiums exceed expected claims: people pay to be rid of a risk whose average is not what frightens them.

The premium is not constant. It is largest when implied volatility is highest — fear is when protection is dearest and most overpriced — and it has narrowed over time in crypto as the market has matured, from twenty-odd points on bitcoin in 2021 to single digits by 2026. Nor is it free money: it is collected on ordinary months and given back, sometimes many months' worth at once, on the crash that implied volatility did not see coming. A strategy that sells volatility is a strategy that is paid the premium and holds the tail.

For example

On a given day DVOL reads 48. Over the next thirty days bitcoin's daily moves work out to an annualised 36. The premium that day was 12 points: the market paid for 48 and got 36. Someone who sold a 30-day straddle at 48 and hedged it collected roughly that difference. Someone who bought one for protection paid it.

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Why it matters to you

If you buy options — for protection, or to bet on a move — the premium is the built-in cost you are paying over and above the movement you can expect, and it is largest exactly when you most want protection. If you sell options, it is your income, and knowing how it is paid back on the bad month is the whole job.

⚠ Treating the premium as a steady yield

A median premium of ten points hides the months where realised volatility came in forty points above implied. On bitcoin those months were sudden crashes that began from ordinary readings — the index caught up with the move on the day of the move. The premium is a fee for holding that risk, not a return that arrives regardless of it.

Frequently asked questions

What is the volatility risk premium?

The average amount by which implied volatility exceeds the realised volatility that follows it. It is positive most of the time because option buyers pay extra for protection against extreme moves, and it is collected by option sellers.

Why is implied volatility usually higher than realised?

Because real price moves have fat tails — extreme days come far more often than a bell curve predicts — and the options market charges for that on every day, not just the extreme ones. Buyers accept the overpayment on ordinary days as the price of being covered on the rare day that matters.

Is selling volatility profitable?

On average, in most years, yes — that is what a positive premium means. But the profits arrive in small steady amounts and the losses arrive in large sudden ones, on the months implied volatility underestimated. Whether it is profitable for a given trader depends entirely on how those months are survived.

Read the full guide

DerivativesHow to Read Implied VolatilityImplied volatility is the options market's forecast of how much a price will move. Deribit's DVOL puts one for bitcoin and ether in a single number, like the VIX. Five and a half years of daily readings scored against what followed say the forecast runs high on most days, misses on the crash, buys too much protection against ordinary days and too little against the day that matters — and that the 'fear index' spent two years rising on rallies instead.12 min read

Related terms

Call optionA call option is a contract giving the buyer the right — but not the obligation — to buy an asset at a fixed 'strike' price before a set expiry date. Call buyers are betting the price will rise; their risk is capped at the premium paid, while the potential profit is open-ended.Cash-secured putA cash-secured put is an options strategy where you sell a put option while setting aside enough cash to buy the stock if you're assigned. You collect the premium as income; in exchange, you agree to buy the stock at the strike if it falls there. It's a way to get paid to buy a stock you want at a lower price.Covered callA covered call is an options strategy where you own 100 shares of a stock and sell a call option against them. You collect the premium as income; in exchange, you cap your upside at the strike. It's a popular way to generate income on shares you're happy to hold or sell.DeltaDelta measures how much an option's price moves for each $1 change in the underlying. A delta of 0.60 means the option gains about $0.60 if the stock rises $1. It ranges from 0 to 1 for calls (0 to −1 for puts) and doubles as a rough probability the option finishes in the money.
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