Options 101 · Module 5 of 10

Implied volatility and earnings IV crush

In this lesson

Explain IV, estimate an implied move from an ATM straddle, and explain IV crush after scheduled events.

5
short parts
12
questions
~15
minutes
Read the whole lesson on one page

Implied volatility and earnings IV crush: the lesson

What implied volatility means

Two stocks trade at $50. The first one's at-the-money call costs 1.00. The second's costs 3.00. The second stock's options are pricing a bigger move. That bigger expected move is higher implied volatility, or IV.

Reading the implied move

Before earnings, you can read the move options are pricing in. Add the at-the-money call and put. That pair is called a straddle.

Options on a $100 stock with 5 days left and IV 80%, just before a report. Prices per share.
CallStrikePut
6.67951.67
3.731003.73
1.841056.84

Stock at $100. Shaded prices are in the money; the outlined row is at the money.

Options on a $100 stock with 5 days left and IV 80%, just before a report. Prices per share.

Illustrative numbers, not real quotes.

  1. Step 1: The 100 call costs about 3.73 and the 100 put about 3.73.
  2. Step 2: The straddle costs about 7.46, which we round to 7.50.
  3. Step 3: Implied move = 7.50 ÷ 100 = about ±7.5%.

It's a rule of thumb. The real move can be smaller or bigger.

IV crush

After the report the uncertainty is gone, so IV drops, here from about 80% to 35%. The extra price for the event comes out of the options. That's IV crush. A report is one day, so near-dated options carry the biggest share of that event premium.

05109095100105110Stock price100 call value (per share)
  • Before the report (IV 80%, 5 days left)
  • After the report (IV 35%, 4 days left)
Value of the 100 call across stock prices, before and after the report. The after line is lower everywhere, and the gap is widest at 100. The put behaves the same way.

Model values, not real quotes.

Right on direction, still a loss

  1. Step 1: You pay 7.50 for the straddle, $750 per contract.
  2. Step 2: The stock jumps 5% to $105 and IV falls.
  3. Step 3: The call is worth about 5.00 plus a little time value. The put is nearly worthless. The straddle is about 5.30.
  4. Step 4: 5.30 − 7.50 = −2.20, a loss of about $220.
+$750$0−$75090100110Stock price at expirationStrike 10092.50107.50

Stock at $108.00: profit of $50

Breakevens
92.50 and 107.50
Max loss
$750
Long 100 straddle bought for about 7.50, at expiration. It breaks even at 92.50 and 107.50.

Sellers don't always win

Long straddle (buyer)Short straddle (seller)
Wins if the move is bigger than priced inWins if the move is smaller than priced in
Hurt by IV crushHelped by IV crush
Max loss: the premiumLoss can be large

Worked example: A $100 stock, 5 days to expiration, report after tonight's close

Illustrative numbers, not real quotes.

Before the report, IV is about 80%. The 100 straddle (the 100 call plus the 100 put) costs about 7.50, so the implied move is 7.50 ÷ 100 = about ±7.5%.

After the report, with 4 days left and IV down to about 35%, here is the straddle the next day:

Stock next dayStraddle valueP&L per straddle
95 (−5%)about 5.25about −$225
100 (flat)about 2.90about −$460
105 (+5%)about 5.30about −$220
108 (+8%)about 8.05about +$55
  • Take the +5% row. The call is worth about 5.00 in intrinsic value, and the put is nearly worthless, so the straddle is worth about 5.30. You paid 7.50.
  • The flat row loses the most. Both options lose almost all their extrinsic value when IV falls from 80% to 35%.
  • The stock was right on direction at 105, and the straddle still lost. Only a move bigger than the implied move made money.

Education only, not investment advice. Options involve risk. Read the OCC's Characteristics and Risks of Standardized Options. Example numbers are illustrative.