One of the most frustrating experiences for new options traders is buying a call or put before earnings, correctly predicting the direction, and still losing money. The culprit is almost always volatility crush. Understanding this phenomenon is essential for anyone trading options around binary events.
What is Volatility Crush?
Volatility crush (also called IV crush) is the rapid decline in implied volatility that occurs after an anticipated event, most commonly an earnings announcement. This drop in IV causes option prices to fall sharply, regardless of the underlying stock's direction.
Simple version: Before earnings, options are expensive because nobody knows what will happen. After earnings, the uncertainty is gone, so options become cheaper. This price drop is volatility crush.
Why Does Volatility Crush Happen?
Implied volatility represents uncertainty about future price movement. Before a major event like earnings:
- Nobody knows if the company will beat or miss expectations
- The stock could move 5%, 10%, or even 20%
- Traders pay extra for options to capture this potential move
- This extra demand drives up implied volatility
After the earnings announcement:
- The uncertainty is resolved
- The stock has made its move (or not)
- There is no longer a reason to pay extra for volatility
- IV collapses back to normal levels
Example of IV Crush
Stock ABC is trading at $100 before earnings. A $105 call expiring in one week costs $4.00 with IV at 80%.
Earnings are announced. The stock goes up 3% to $103. You were right about the direction.
But IV drops from 80% to 35%. Your $105 call is now worth only $1.50.
Result: You correctly predicted the move but lost $2.50 per contract (62.5%) due to IV crush.
When Does Volatility Crush Occur?
IV crush happens after any binary event that removes uncertainty:
- Earnings announcements: The most common trigger
- FDA drug decisions: Approval or rejection news
- Legal rulings: Court decisions in major cases
- Product launches: Apple events, game releases
- Economic data: Jobs reports, Fed decisions
- Elections: Political outcomes
How Much Does IV Typically Drop?
The magnitude of IV crush varies but follows patterns:
Typical Earnings IV Crush
- Volatile stocks (TSLA, NFLX): IV can drop 30-50%
- Moderate stocks (AAPL, MSFT): IV typically drops 20-35%
- Stable stocks (JNJ, PG): IV may drop 15-25%
FDA Decision IV Crush
- Biotech stocks can see IV drop 50-70% after FDA decisions
- This is one of the most extreme forms of volatility crush
Strategies to Avoid IV Crush Losses
Strategy 1: Buy Options After Earnings
Wait until after the earnings announcement and IV crush has occurred. You will pay less for options and avoid the crush. The downside is you miss the potential earnings move.
Strategy 2: Sell Premium Before Earnings
Instead of buying options, sell them to collect the inflated premium:
- Iron condors: Profit if stock stays within a range
- Credit spreads: Profit if stock moves in your direction or stays flat
- Strangles: Profit from IV crush (higher risk)
Selling Premium Example
Before earnings, you sell an iron condor on ABC for $3.00 credit.
Your breakeven range is $95 to $112 (stock at $100).
After earnings, stock moves to $103. IV crushes.
Your iron condor can now be closed for $0.80.
Result: You keep $2.20 of the $3.00 collected.
Strategy 3: Use Spreads Instead of Naked Options
Spreads reduce your exposure to IV crush:
- Buy a call spread instead of a naked call
- Buy a put spread instead of a naked put
- The short option offsets some of the IV crush on the long option
Strategy 4: Go Further Out in Time
Options with more time to expiration are less affected by IV crush:
- Weekly options are devastated by IV crush
- Monthly options lose less to IV crush
- LEAPS are minimally affected
Strategy 5: Account for IV Crush in Your Analysis
Before buying options for an earnings play:
- Calculate how much IV might drop
- Determine how much the stock needs to move to overcome the crush
- Only take the trade if the expected move exceeds the breakeven
Calculating the Expected Move
Markets price in an "expected move" for earnings. You can calculate it:
Expected Move Formula: (ATM Straddle Price / Stock Price) x 100 = Expected % Move
Example: Stock at $100, ATM straddle costs $8. Expected move = 8%.
To profit from buying options, the stock needs to move MORE than the expected move. If the straddle prices in an 8% move and the stock only moves 5%, straddle buyers lose money.
Profiting From Volatility Crush
Instead of being a victim of IV crush, you can profit from it:
Selling Iron Condors
- Collect premium before earnings
- Set strikes outside the expected move
- Let IV crush work in your favor
- Risk: large moves can cause significant losses
Selling Strangles
- Higher premium than iron condors
- Undefined risk (not recommended for beginners)
- Works well when expected move is overpriced
Calendar Spreads
- Sell near-term options (high IV)
- Buy further-out options (lower IV impact)
- Profit from the differential IV crush
When Not to Play Earnings
Sometimes the best trade is no trade:
- When IV is not significantly elevated (no edge)
- When you have no directional conviction
- When the expected move seems reasonable
- When you cannot afford the potential loss
Common Mistakes to Avoid
- Buying weekly options before earnings: Maximum IV crush exposure
- Ignoring the expected move: You need the stock to move MORE than priced
- Holding through earnings unintentionally: Know your expiration dates
- Selling naked options: Unlimited risk if stock moves huge
- Oversizing positions: Earnings are binary; size accordingly
Track Your Earnings Trades
Pro Trader Dashboard helps you analyze how IV crush affected your earnings trades and improve your strategy.
Reading the Signs
Before trading earnings, check these indicators:
- IV Percentile: Is IV actually elevated? (Should be above 50%)
- Historical earnings moves: How much has the stock moved in past earnings?
- Expected move vs historical: Is the market pricing in more or less than usual?
- Straddle price: Is the cost reasonable for the potential payoff?
Summary
Volatility crush is the rapid decline in implied volatility after earnings and other binary events. It causes option prices to drop sharply, often resulting in losses for option buyers even when they predict direction correctly. To avoid IV crush losses, consider selling premium, using spreads, choosing longer expirations, or simply not trading earnings. To profit from IV crush, sell iron condors, strangles, or calendar spreads. Always calculate the expected move and only trade when you have a clear edge.
Learn more about trading earnings or read about implied volatility.