Using the index, people can have the same insights of the market that people that look into traditional markets have using traditional volatility indices:
Understand the expected Volatility of the market
Develop trading strategies for short-term gains
Hedge their portfolio against price fluctuations.
There are a multitude of trading strategies users can implement using the CVI Index. As an example, below we describe 3 of the most common strategies for trading the volatility index:
Black swan — Hedging Strategy
If a trader expects that some large-scale shock can affect the whole market, he can buy CVI and, if the market downturn really happens, the trader can make substantial gains from the trade.
For example, if the trader entered the market on some of the first days of February 2020 when the CVI level was at 50, he could have made a 260% profit closing the position when the CVI level was at 180 a few days later.
Overheated market — Hedging Strategy
Unlike the previous trading strategy, this is a much more common situation for all financial markets. For example, let's look at the Ethereum price chart at the beginning of September of 2020:
The explanation for this market behavior is the overbought state of the market into the “DeFi” tokens — a very promising and quickly developing market segment, but no investment market can be stable being overbought. As a result, when the stock market plunged by approximately 5%, cryptocurrency markets lost much more and the Defi components which are based on Ethereum got the most significant drawdown.
The possible strategy of using CVI for this situation is to open a long position of the CVI Index when volatility is rising in the market.
Following the example of the graph above, if a trader starts buying into CVI in the last days of August, then the gains of the long position of the CVI index would have compensated most of his losses in Ethereum all through September.
Back slope — speculative strategy
As demonstrated in many previous examples, after a sharp surge CVI usually goes down to its average levels. If a trader sells CVI at such a slope, the trader can make a profit once the index is going down. Like all speculative trades, this strategy is more sophisticated and requires more analysis, but on average it can be more profitable than the others described above.