Volatility crush is often used when describing the swift decrease in implied volatility of the option after underlying stock’s earnings or when other significant news events are announced.
A volatility crush transpires when the implied volatility of an option rises before an earnings announcement – when the stock’s future price path is most vulnerable. It then falls once the earnings and information are announced.
What Is Implied Volatility?
You can determine the option’s prices by calculating the stock’s current price, the option’s strike price, the length of time until the expiration date, and the suspected volatility in the stock’s price over that length of time.
The greater the price of an option, the greater the premium. This is in comparison to the difference between the current price and the strike price of the underlying stock. Greater premium accounts for the uncertainty surrounding that stock’s expected volatility.
The premium that an option commands is measured by the implied volatility that investors expect.
Trading and Volatility Crush
The price action in the options market encompasses a volatility crush representing several distinct profit opportunities.
Option prices often rise, heading into an earnings announcement. The premiums, not necessarily the overall cost, will fall as the actual volatility crush occurs after the earnings announcement.
It depicts a period of high price volatility in the options market that is an exemplary hunting ground for day traders of all kinds.
Putting it all together
Volatility crushes represent predictable patterns of price movement in the options market that traders can use to their advantage.
When you understand the increasing rate of premiums before an earnings announcement followed by the likely decrease in implied volatility, you will make smarter, more informed decisions.