What Is IV Crush?

IV crush is a phenomenon that tends to catch many beginners off guard. It is a situation where the extrinsic value of an option contract declines sharply as a result of a significant event occurring, such as the reporting of corporate earnings or a regulatory announcement.

In an IV crush, even though the price of a stock moves in a trader’s favor, they can still potentially face a losing trade. As a result, it is important for traders to be intimately familiar with what an IV crush is and how to avoid it. To understand what an IV crush is, we first need to cover implied volatility (IV).

What Is Implied Volatility?

Implied volatility is a metric used by traders to provide a forecast for the likely future change in a security’s price. It is used for forecasting price moves, supply and demand, as well as for pricing options contracts.

As implied volatility increases, it results in options having a higher premium. This is due to the fact that the price of options are valued based on intrinsic and extrinsic value (i.e. the risk premium). As a company’s earnings date approaches, there is a rise in the uncertainty of the company’s future stock price.

This translates into a rise in demand for related options contracts, which causes their extrinsic value to rise, which then leads to an increase in implied volatility. When implied volatility rises very high, it sets up the option contract for being at risk of an implied volatility crush. You can read a full guide on implied volatility here.

Implied Volatility Crush

An implied volatility crush occurs when implied volatility decreases very rapidly. This will typically occur right after an event has been occurred, as it is caused by the market going from an environment where there is unknown information to an environment where the information is now known.

Put simply, it means the market has moved from uncertainty to certainty. As alluded to earlier, this can be something like an earnings announcement, where market participants speculate on the results and then react once the results are released.

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Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

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