Imagine placing a trade expecting big profits, only to see your option lose value—even though the underlying stock moved as expected. This phenomenon is known as volatility crush, and it’s a hidden risk that catches many options traders off guard. This article will explain what volatility crush is, why it happens, and how options traders can manage and mitigate this risk.

This guide on volatility crush explains what it is, why it happens, and how it can have a super negative effect on options traders who don’t see it coming. Knowing how to spot volatility crush before it occurs is an invaluable tool for options traders, so we’ve included a detailed section on how to identify situations where volatility crush (or IV crush) is likely. As always, we’ve included some practice steps and tips for how to avoid this phenomenon altogether to save yourself some heartache during your options trading sessions. 

What Is Volatility Crush?

Also known as “IV crushes,” implied volatility crush or volatility crush occurs when an option or a group of options decreases suddenly and sharply. A volatility crash typically happens around the time of a company’s earnings announcement or some other kind of major event where volatility is expected to increase. IV crush can have a significant impact on options: option prices decrease when volatility decreases, longer-dated options are more sensitive to the impacts of IV crush, and they have a bigger impact on options that are out of the money. 

Simply put, a sharp decline in an option’s implied volatility (IV), leads to a rapid drop in the option’s premium. Even if the stock price moves in the expected direction, the drop in IV can significantly reduce the option’s value. A few ways that traders can get around the negative impacts of IV crush include using strategies like iron condors or vertical spreads where you’re buying and selling options at the same time. It’s also imperative for traders to manage their positions around the risk associated with a potential volatility crush. 

Why Does Volatility Crush Happen?

Implied volatility is a key component in volatility crush and it plays a significant role in options trading because it reflects the market’s expectations of how much the price of the underlying asset will fluctuate in the future. Implied volatility acts as a gauge of market uncertainty which means that it can have an impact on options pricing. 

When looking at the Black-Scholes model, options prices can be significantly impacted by implied volatility due to IV representing the market’s expectation of how the price will fluctuate in the underlying asset. Implied volatility is the only Black-Scholes model variable that can’t be observed directly. High IV signifies market uncertainty, while low IV is a good indicator of stability and little expectation for significant price changes. 

In the context of the Black-Scholes model, implied volatility is calculated by inputting factors like strike price, time until the expiration date, stock prices, and interest rates. Using these factors helps traders find the volatility that creates option prices that match the market price. When IV increases, the premium for the option also increases because traders are expecting larger price fluctuations in the market. 

While there’s market anticipation going into an event like the release of a company’s earnings report which tends to drive IV up, the uncertainties are put to bed coming out of the event and volatility tends to wane including the deflation of option premiums. When IV drops sharply, this is what’s known as “post-event adjustment” which leads to “IV crush.” This happens due to traders buying options at a higher price when large price swings are anticipated but the actual price movement is a lot less than expected. 

How Volatility Crush Impacts Options Traders

Understanding how IV crush works is beneficial for options traders because it can have ripple effects on the profitability of each trade that’s conducted around an event where IV is expected to rise, along with option premiums. We’ll address the main ways in which IV crush can have a significant impact on traders, both in a good and bad sense. 

Loss of Premium

Even if the underlying stock moves as predicted, the reduced IV can erase profits. Traders lose their premium when there’s a significant drop in the options contract’s price as it loses its value because the market’s perception of future price movement has become less certain. Out-of-the-money options are particularly vulnerable as they rely heavily on time value (options prices decline as IV declines).

Impact on Long Options

IV crush can be especially detrimental to long calls and long puts purchased before high-volatility events. Traders are paying more money than usual for these positions as high IV before an event drives up the price of option premiums. Even if the underlying stock moves favorably for the trader, sharp drop-offs in IV following the event can lead to significant losses for the buyer of the option.

Limited Impact on Short Options

Options traders can make a profit by selling options at a higher price when implied volatility is higher before an event and then buying them back after the event once IV drops off and drives down the underlying security’s price. This is one of the great benefits of IV crush for traders who sell options, as they profit from the drop in premium.

Identifying Situations Where Volatility Crush Is Likely

Maybe you’re new to options trading and you’re interested in executing some trades around IV crush, but you’re not certain which situations are best for these kinds of moves. This next section of our guide is especially helpful with outlining the best situations and scenarios where IV crush trades and plays can be beneficial for traders who want to secure a profit around major market events. 

Earnings Announcements

Leading up to the release of a company’s earnings report, options prices will generally rise due to abounding uncertainty about the stock’s future price movements. Stocks often experience volatility crush right after earnings reports, however, when the news is released the future becomes more certain for traders.

Product Launches and Regulatory Decisions

In addition to earnings announcements, there are also high-uncertainty events that lead to inflated IV like new products introduced to the market or changes in a company’s operations due to new regulations. Like earnings reports, these events can cause IV to rise which are prime opportunities for traders to execute IV crush moves.

Economic Reports

Events like Federal Reserve meetings and inflation reports can trigger volatility crush. News on the future of the economy can create a lot of fear with trades which increases expected volatility along with option premiums. It’s more expensive to trade in uncertain markets. Once the uncertainties around the report have waned, option premiums lose value as implied volatility decreases suddenly.

Using an Options Chain

There are many instances, however, where IV crushes aren’t as apparent as events like earnings announcements, economic reports, regulatory decisions, or product launches. It’s for times such as these where option chains can come in handy—they are made for traders who’d like to spot unusually high IV levels that signal potential volatility crush.

How to Protect Yourself from Volatility Crush

There are many different risks that options traders must manage and volatility crush is one of those risks. Learn the best moves you can make to protect your capital and positions against sudden drops in IV coming off the heels of a market event. 

Avoid Buying Options with Inflated IV

The best move of them all to protect yourself against IV is to check the option’s IV percentile and compare it to historical volatility. The more you can avoid buying options with an inflated IV, the less susceptible you’ll be to getting caught in the crosshairs of an IV crush.

Use Strategies That Benefit from Volatility Crush

Short volatility options strategies are the way to go like short straddles, short strangles, and credit spreads. It’s super beneficial for traders who aim to profit by selling options at a higher premium when volatility is higher.

Time Your Trades Carefully

Enter long options positions after high-volatility events to avoid the crush. Buying options when the IV has already peaked and is starting to decline lets traders benefit from a more stable price premium.

Monitor the IV Rank

Understand the IV rank and IV percentile to assess whether the IV is high or low. Traders need to keep an eye on each stock’s IV rank which can tell them how the current volatility of an option compares to its historical volatility over the past year. This lets traders gauge if IV is too low or too high.

Examples of Volatility Crush in Action

Let’s take a look at some hypothetical examples that best illustrate the idea of volatility crush in the options trading market. 

Example 1

The first scenario involves a trade where a long call on a stock with high pre-earnings IV (implied volatility) results in losses after the company’s earnings announcement. If the stock doesn’t rise significantly or even falls below the strike price before the contract’s expiration date, the trader can lose money. This is even the case if the earnings report is good. What occurred was the high implied volatility inflated the options price which led to a larger loss when the price didn’t meet expectations.

The Key Steps of the Scenario

1. Traders will buy a long call with the expectation that there will be a large price increase after a positive earnings report. The long call option, in this case, is for a company with high implied volatility. 
2. The stock price declines or stagnates when the company releases its report and the earnings are less than expected by the market. 
3. The option’s time value will decrease as the expiration date of the options contract gets nearer. The result here is the further devaluation of the contract’s value. 
4. The stock price might stay well below the strike price once the expiration date arrives. In this case, the option expires as worthless. The ultimate result is that the trader loses the premium they paid for the position. 

Key Takeaways

• Market volatility will often spike around earnings announcements as traders are initially reacting to the results. 
• Stocks that have high IVs also have more expensive options. This is because of the increased uncertainty, at least according to the market’s perception. 
• Stocks that don’t rise considerably following the earnings report will have long call options that will expire worthless. This is the same for stock prices that fall below the strike price. In either case, traders lose the premium they paid. 

Are there any ways that a trader can manage the IV crush risk associated with this first example? Yes, of course, there are: 

• Protective Strategies: There is a way for traders to limit their losses, while also allowing room for considerable gains. This is done using a protective strategy where the trader combines a long call with a short put option. These are known as covered calls and straddles. 
• Shorter Expirations: Traders can make the simple move of buying options contracts with a shorter term until expiration. The lower time value can work in their favor by reducing the time decay risks significantly. 
• Good Research and Analysis Can Get Traders Around IV Crush: Traders can often get around possible IV crushes by doing a deeper level of research and analysis into each option contract they want to buy. They can do this by taking a deeper look into the market’s expectations around the stock or company, monitoring the current implied volatility levels, and looking thoroughly into the company’s fundamentals. 

Example 2

The next scenario involves the trader using a short straddle strategy on the same stock, in an attempt to profit from the post-earnings volatility drop. Traders profit by selling a call and put option with the same strike price and expiration date. They must look for stocks with high IV before earnings (which is a significant sign that a large potential price swing is imminent). The ideal course of action is for traders to enter the position a few days before the earnings. At this time, the options are priced high because of the high volatility around the earnings report. Once earnings have passed, traders can profit from an IV decline if the stock price stays relatively stable. 

Key Takeaways

• Inflated prices are the norm before an earnings announcement because the market is usually experiencing high IV with the uncertainties of possible price movements (direction and magnitude). 
• IV usually declines after earnings if the stock price stays relatively stable. Traders can enjoy a profit due to this decline in IV when the value of the options sold also decreases. 
• Traders can collect a nice premium upfront when they sell a call and put a contract at the same time at the same strike price. 

When you’re dealing with short straddles to profit from a drop in IV after earnings, there are a few other important considerations to keep in mind. It’s advisable to use stop-loss orders with short straddles to limit potential losses if the stock price moves in an unexpected way (there’s an unlimited risk if the stock prices move drastically in either direction following earnings). Traders have the best success with the short straddle when the market is expecting a significant price changeup after the earnings report is released but the movement is going to be smaller than expected. 

Comparison of Option Premium Before and After Volatility Crush

Key Indicators to Watch to Avoid Volatility Crush

Traders who make a point of wanting to avoid IV crush need to use these key indicators in their options trading sessions for maximum effect. Keep a close eye on IV rank/percentile, earnings IV crush analysis, and option Greeks as a way of keeping far away from the disastrous results of an unexpected IV crush. 

Implied Volatility Rank (IVR) and Percentile

Traders can use both of these tools to assess whether IV is high or low compared to historical levels. Rank and percentile also help with identifying scenarios where options could be overpriced because of excessively high implied volatility. 

IV Rank

This tool indicates where the current implied volatility is sitting in the context of its historical range. It comes in the form of a percentage. 

IV Percentile

This indicator shows how often the current IV has been exceeded within the last year. Like IV rank, it’s also expressed as a percentage. 

Stocks that come with a high IV rank or percentage could be signaling that the current options are being priced with high volatility anticipation. This could lead to a major price drop if the volatility following earnings or any other event ends up being much lower. In these cases, it’s best to use strategies like covered calls or cash-secured puts, where traders can profit from a decline in volatility. 

Earnings IV Crush Analysis

Earnings IV crushes is a considerable drop in IV that occurs after an earnings announcement. An analysis of earning IV crush can give traders a better idea of how to avoid IV crush altogether. Traders can use tools like options scanners to identify stocks with historically high earnings IV crushes.

Option Greeks

IV crushes can have a considerable effect on the Greeks, especially when it comes to big dropoffs in the Vega value which measures sensitivity to changes in IV. option pieces become less sensitive to future changes in volatility as the uncertainty surrounding earnings begins to wane. 

Using the Greeks can help traders find strategies that have a lower Vega value (the sensitivity changes in IV). Short straddles and strangles are both good courses of action (both involve selling a call-and-put option at the same strike price). Selling options when IV is high is also a good call for traders looking to avoid IV crushes including techniques like covered calls or cash-secured puts. 

Practical Tips for Options Traders

While trading options and doing your best to avoid IV crushes around earnings announcements and other significant events, there are some good practices that traders should be exercising while analyzing the market and using strategies that help them navigate the volatility that comes with these events. Check out these practical tips for traders who are looking for some good tools for analyzing the market and practicing trades ahead of time without risking their capital. 

Use Options Analysis Tools

If you’re interested in accessing the best options analysis tools the market has to offer but don’t want to use a separate platform from your brokerage app, may we suggest using the following trading apps which come with top-notch options analysis tools and other helpful resources? 

The Best Options Trading Apps 

Interactive Brokers

Firstrade

Robinhood

Tastytrade

Charles Schwab 

Options Profit Calculator 

Use options calculators to figure out possible profit or loss scenarios and how to effectively read the market and choose a suitable trading strategy to go from there. 

The Value of Paper Trading 

It’s important to note that traders should use demo accounts or paper trading platforms to learn about IV crush and use the right strategies for dealing with it, all without risking any of their capital. Through paper trading, you can learn about simulating trades to see how volatility crush impacts option values and you can do this before using real money and incurring unnecessary losses. 

Adjust Your Strategy as Needed

It’s important to pivot to other strategies when the occasion is appropriate. Consider alternative strategies like debit spreads or iron condors to limit the impact of volatility crush.

Debit Spreads

Buying and selling options with different strike prices at the same time. Traders using debit spreads are buying options with higher premiums and selling options with lower premiums. Debit spreads are best used when the trader expects the price difference between the two options to widen further. This is when a profit can be realized. They can also be used to benefit when the underlying security price increases considerably.

The debit spreads ultimately limit the negative impacts of IV crush by hedging against sudden drops in implied volatility, done through the trader simultaneously buying and selling two contracts at different prices. When the crush occurs and the IV of one option decreases, the other option in the debit spread can partially offset that loss. 

Iron Condors

This move involves the trader buying long options above and below the short strikes to define the position’s risk—it’s done by buying and selling a combination of calls and puts. Selling call and put spreads at the same time results in a profit from low volatility, time decay, and minimal price movements.

Again, the key behind the iron condor limiting IV crush is in its design. The simultaneous buying and selling of options at higher and lower implied volatilities let traders profit when an IV crush occurs and the underlying asset decreases greatly.

Don’t Let IV Crush Catch You Off Guard

Volatility crush is a hidden risk that can wipe out profits, even when the underlying stock moves as expected. Understanding IV and timing your trades correctly can help you avoid falling victim to volatility crush. Use options chains to get clues on when a volatility crush might be in the works, but you can usually expect it around the time of earnings announcements, economic reports, regulatory changes, or new product releases. 

Traders can effectively stay ahead of volatility crushes by avoiding buying options with inflated IVs, using strategies that benefit from volatility crushes like iron condors, timing your trades carefully, and monitoring key indicators like IV rank or percentage for clues of an imminent IV crush. Stay informed about volatility by using tools that track IV rank and IV percentile, and explore strategies that either avoid or benefit from volatility crush.