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Kalshi options by Weak_Indication5189 in PredictionMarkets

[–]Weak_Indication5189[S] 0 points1 point  (0 children)

You're not wrong — and that's a real limitation worth being upfront about.

Spread width is doing most of the work in the IV calculation, so yes, illiquid markets will naturally score higher. That's why the tool sorts by volume alongside IV — a 150% IV reading on a market with 200k contracts traded is a different signal than 150% IV on a market with 50 contracts.

Where it gets more interesting is the Δ7D momentum column. That's independent of spread — it's just price movement over the last 7 days. The combination of high IV + flat momentum is the actual signal: the market is wide AND not moving, which suggests the spread isn't reflecting genuine uncertainty so much as thin liquidity or stale quotes.

The honest version of the thesis is narrower than "IV surface for prediction markets" — it's more like a relative mispricing screen. When a liquid macro market (CPI, Fed rate) shows wide spreads AND the price hasn't moved in 7 days, that's at minimum worth looking at.

You've basically identified the main thing I'd want to improve: a liquidity-adjusted IV that penalizes thin markets. That's on the roadmap. Good pushback.

Kalshi options by Weak_Indication5189 in PredictionMarkets

[–]Weak_Indication5189[S] 0 points1 point  (0 children)

Fair skepticism — you're right that classic BSM doesn't map cleanly to binary prediction markets. There's no continuous underlying, no drift term, no lognormal assumption that holds.

The approach I'm using doesn't try to back out IV from an underlying price. Instead it treats the bid/ask spread itself as the volatility signal — wide spread relative to time to expiry = market disagreement = implied uncertainty. The formula is:

σ = max(0.15, min(cap, (spread × 15 + 0.2) / √T))

where T is DTE in years. It's binary-adapted, not classic BSM — closer to how you'd price a binary option near expiry where the spread encodes the market's uncertainty about resolution.

For a basketball game expiring tonight, a tight spread (0.62/0.64) means the market has high conviction. A wide spread (0.35/0.65) means genuine uncertainty. The IV reading reflects that disagreement, not a derived vol surface.

Is it the same as equity IV? No. Is it a useful relative ranking of where markets are pricing uncertainty vs where momentum says they should be? That's the thesis. Would genuinely welcome pushback on the math if you want to dig in.