Volatility crush is one of the most predictable phenomena in options trading. It happens when implied volatility drops sharply after an anticipated event, causing option prices to fall dramatically. Understanding volatility crush can help you avoid costly mistakes and even profit from this predictable pattern.
What is Volatility Crush?
Volatility crush, also called IV crush, occurs when implied volatility (IV) drops rapidly. This most commonly happens after earnings announcements, but can occur after any anticipated event that removes uncertainty from the market.
The simple version: Before a big event like earnings, options become expensive because nobody knows what will happen. After the event, uncertainty is gone, so options become cheaper. This sudden drop in option prices is volatility crush.
Why Does Volatility Crush Happen?
Option prices are heavily influenced by implied volatility. When traders expect a big move, they bid up option prices, which increases IV. Once the event passes:
- The anticipated move has either happened or not
- Uncertainty is removed from the equation
- Traders no longer need to pay premium for expected volatility
- Option prices collapse as IV normalizes
Earnings and Volatility Crush
The most common and predictable volatility crush occurs around earnings announcements. Here is the typical pattern:
Earnings IV Crush Pattern
- 2-4 weeks before earnings: IV starts rising as the announcement approaches
- 1 week before: IV increases more rapidly
- Day before earnings: IV peaks at its highest level
- Morning after earnings: IV crashes 30-70% overnight
Example of IV Crush
Imagine a stock trading at $100 before earnings:
- The at-the-money call option costs $5.00 with IV at 80%
- Earnings are announced and the stock moves to $103
- IV drops from 80% to 35% overnight
- Despite the stock rising $3, the call option is now worth only $4.50
The option buyer was correct about direction but still lost money because the IV crush overwhelmed the directional gain.
How to Avoid Getting Crushed
If you are buying options around earnings, IV crush is your enemy. Here is how to protect yourself:
1. Check IV Percentile
Before buying options, check the IV percentile or IV rank. If IV is in the 80th percentile or higher, you are paying a significant premium that will likely disappear after earnings.
2. Calculate the Expected Move
The options market prices in an expected move based on the at-the-money straddle price. To profit buying options, the stock needs to move MORE than the expected move.
Expected Move Calculation
If the at-the-money straddle costs $8 and the stock is at $100:
- Expected move = $8 (or 8%)
- The stock needs to move beyond $92 or $108 for straddle buyers to profit
- Historically, stocks move less than expected about 70% of the time
3. Use Spreads Instead of Naked Options
Buying a debit spread instead of a single option reduces your IV exposure. Since you are both long and short an option, the IV crush partially cancels out.
How to Profit from Volatility Crush
Since volatility crush is predictable, smart traders position themselves to benefit from it:
Strategy 1: Sell Iron Condors Before Earnings
An iron condor profits when the stock stays within a range and when IV drops. Open the position when IV is elevated and close it after IV crushes.
Strategy 2: Sell Strangles or Straddles
More aggressive traders sell strangles to collect the inflated premium before earnings. This is riskier but captures the most premium.
Strategy 3: Use Butterfly Spreads
A butterfly spread centered at the current price benefits from the stock not moving much and from IV declining.
Strategy 4: Calendar Spreads
Sell the front-month option (high IV) and buy a back-month option (lower IV). After earnings, the front-month IV crushes more than the back-month.
Managing Risk with Volatility Crush Trades
While selling premium into earnings sounds appealing, there are real risks:
- Large gap risk: If the stock gaps beyond your short strikes, losses can be significant
- Undefined risk strategies: Naked strangles have unlimited loss potential
- Black swan events: Occasionally stocks make massive moves that overwhelm collected premium
Risk Management Rules
- Never risk more than 1-2% of your account on a single earnings trade
- Always use defined risk strategies like iron condors or credit spreads
- Set stop losses or adjust if the stock approaches your short strikes
- Diversify across multiple earnings plays to spread risk
Other Events That Cause Volatility Crush
While earnings are the most common, other events also trigger IV crush:
- FDA announcements: Biotech stocks see massive IV crush after drug decisions
- FOMC meetings: Interest rate decisions affect market-wide volatility
- Product launches: Apple events, gaming console releases, etc.
- Legal verdicts: Companies with pending litigation
- M&A announcements: Merger and acquisition news
IV Crush vs Time Decay
Both volatility crush and theta decay reduce option prices, but they work differently:
- Theta decay: Slow, predictable erosion as expiration approaches
- IV crush: Sudden, dramatic drop triggered by an event
Premium sellers benefit from both, but IV crush provides a much faster profit opportunity.
Track Implied Volatility Across Your Trades
Pro Trader Dashboard shows you IV levels for all your positions, helping you identify high IV situations and potential volatility crush opportunities.
Summary
Volatility crush is a predictable drop in implied volatility after anticipated events like earnings. Option buyers can lose money even when they are right about direction because of IV crush. Smart traders either avoid buying expensive options before events or position themselves to profit from the volatility decline by selling premium.
Want to learn more about volatility? Check out our guide on implied vs historical volatility or learn about the VIX index and market-wide volatility.