Earnings and IV Crush
Before earnings everyone rushes to buy options and IV gets pushed up. Once the results are out, uncertainty vanishes and IV drops instantly, so you can lose money even if you called the direction right.
Risk warning: forex, CFDs, options, futures and crypto assets usually involve leverage or high volatility, and you can lose more than you put in. This lesson only teaches the concepts; all numbers are for illustration and are not investment advice.
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Text version · Advanced Option Strategies, lesson 3: “Earnings and IV Crush”
Before earnings everyone rushes to buy options and IV gets pushed up. Once the results are out, uncertainty vanishes and IV drops instantly, so you can lose money even if you called the direction right.
Before the event, options get bid up
Before earnings or a rate decision, everyone wants to buy “insurance”, pushing implied volatility (IV) very high: the options have already charged for a “big move” in advance.
After the release, IV crashes
Once the result is out, the uncertainty is gone, IV falls back fast and the options' time value shrinks sharply. That's IV crush. The stock's actual move has to be bigger than the market expected for the buyer to profit.
Straddle price = the market's expected move
The price of an at-the-money straddle is roughly how much the market expects the stock to move after the event. A straddle on a $100 stock selling for $8 means the market is betting on “about ±8%”. You're not betting on direction, but on “more than that”.
Key takeaways
- IV is often high before an event, so options already price in the "expected big move".
- After the event IV collapses and the options' time value shrinks sharply. This is IV crush.
- If you buy options to bet on an event, the stock's actual move has to beat the market's expectation for you to make money.
- The price of an at-the-money straddle is roughly the move the market expects.
Try it yourself
You can do these exercises in this lesson's interactive simulation:
- Click “Default: up 4%”: did this straddle make or lose money? What's in the “If IV unchanged” cell?
- Click “Surge 15%”: how much did you make? Compare with “Move needed after the event to break even”: how big a move do you need to avoid a loss?
- Set the post-earnings IV back to match the pre-earnings IV: how much narrower is the losing zone?
- Lower the pre-earnings IV from 80% to 40% (buying when options are cheap): with the same +8% move, how is the result different?
Quiz and explanations
- 1. You buy a straddle before earnings. Afterward the stock rises 3% and IV drops from 80% to 35%. What's the most likely result?
- Answer: A loss: the move wasn't big enough and the IV drop ate the value.A straddle needs a big move; a 3% rise isn't enough to make up for the loss from the IV collapse.
- 2. Before an event, options' implied volatility is usually…
- Answer: High.Uncertainty is high and lots of people buy options, pushing IV up.
- 3. Before earnings, an at-the-money straddle on a $100 stock sells for $8. Roughly what move does the market expect after earnings?
- Answer: About ±8%.Straddle price ≈ expected move: $8 ÷ $100 ≈ ±8%. If the actual move is smaller, buying the straddle usually loses money.
Terms in this lesson
- implied volatility (IV) (Implied Volatility (IV)): The volatility backed out of an option's market price, reflecting the market's expectation of future swings; the higher the IV, the pricier the option.
- IV crush (IV Crush): After an event like earnings, uncertainty vanishes, implied volatility drops fast and option values shrink sharply.
- straddle (Straddle): Buying (or selling) a call and a put at the same strike; a long straddle bets on a big move, a short straddle bets on no move.