IV Crush

IV crush stands for implied volatility crush and goes along with a sudden drop in previously increased implied volatility. An IV crush happens when the anticipated move on an underlying stock does not occur. Let’s say, a scheduled news event like earnings announcements or planned FDA approvals don’t lead to the anticipated sharp rise or drop in the price per share. Such a situation causes an Implied Volatility crush.

A volatility crush is triggered by a sharp decrease in option volatility. It even happens during sideways markets when market participants expect a potential movement in the underlying stock. Then, all of a sudden, absolutely nothing happens to the price per share. For example, an earnings announcement from Apple (NASDAQ:AAPL) is scheduled for today after the market close. Before the announcement, the implied volatility goes higher because market participants expect a gap up or a gap down on the next market open.

Then, the earnings results do not cause any movement, and the gap on the next day is around 0%. As a result, the options premium will drop because of the implied volatility drops. After all, the stock does not move anywhere. Before an earnings announcement, you can also notice unusual options activity caused by institutional buying and selling of options.

What is Implied Volatility?

Options trading means handling kind of insurance policies. Those are mainly being used by institutions to protect their investments. However, day traders and mid-term investors can also benefit from trading options. The implied volatility affects the option price of call options and puts.

It is crucial to understand that the implied volatility is a frequently changing variable and not gradual. This makes it pretty hard for option trading beginners to deal with. Yesterday, I read a story from a finance blogger who lost 53k due to market volatility in April 2020. That’s why it is important to learn from the best options traders and to apply the strategies learned.

The IV gets triggered to an exponential curve when:

  • The market expects a sharp move because news is scheduled
  • Price gaps to the upside or downside happen due to news like an FDA announcement or earnings report

The more sharply a move is expected, or the stronger the price changes, the higher the implied volatility goes.

Volatility Crush Trading Strategies

Let’s summarize what we talked about so far:

  • Scheduled news events and surprising news events trigger sharp market movements or trigger sharp market movement expectations
  • Sharp market movements or expectations cause an increase in implied volatility
  • An increase in implied volatility causes the option premium to go higher since investors are willing to pay a higher price for the “insurance.”
  • If the anticipated movement doesn’t happen, then the implied volatility faces a sudden drop
  • A sudden drop in implied volatility causes the IV crush

The selling option premium is one of the most frequently used IV crush trading strategies. The idea is to sell the option short to others as long as they are willing to pay a high price for the option premium. However, it is also one of the most misunderstood strategies in the options market.

Option buyers limit their risk by the number of options * 100 * options premium (US options). This is true for buying calls and buying puts. However, selling options means an unlimited risk for the option seller if the options are sold naked. Holding a naked call or naked put overnight is riskier than nearly all other investment and trading styles.

The two important factors when it comes to IV crush trading strategies are:

  • Educate yourself by learning based on reliable free resources or by participating in the best option trading courses
  • Practice under any circumstances with a trading simulator or paper trading account.

Conclusion

A sudden drop in implied volatility causes an IV crush. It mainly happens when a strong price movement does not happen as expected. As a result, the option premium drops significantly, along with the stock price, and opens opportunities to make money on the change in the option price. Option buyers lose money when they hold a call or put an option contract during an implied volatility crush.

The best way to make money with the IV crush is by day trading the option contracts by selling options for the premium and protecting it by either close intraday stops, or protection position with stocks, or options with another strike price or expiration date.

The implied volatility crush often happens after an earnings announcement and causes option prices to drop. The VIX market volatility index can also initiate a crush of implied volatility from a broader market perspective. The higher the broad market VIX, the higher the general option premium, plus the higher the volatility of a related stock, the higher the implied volatility. moves after the earnings announcement, the more the implied volatility will drop when the market opens.

Alexander Voigt, CEO
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Alexander Voigt is the founder of DayTradingZ, was a regular contributor to Benzinga and has been featured and quoted on leading financial websites such as Investors.com, Capital.com, Business Insider and Forbes.