Volatility Crush and Expansion

Implied volatility does not sit still. It tends to build up before scheduled events, such as earnings reports, central bank decisions and major economic releases, and then collapse once the event has passed and the uncertainty is resolved. The collapse is called volatility crush; the build up is volatility expansion. Understanding this cycle explains why traders can be right about direction and still lose money on options, and why selling options before events is popular but risky.

Why volatility expands before events#

Before a known event, there is a known chance of a large move on a specific day. Options that expire after the event must price that extra risk, so their implied volatility rises. Options that expire before the event are unaffected. See Volatility Term Structure.

Why it crushes after#

Once the news is out, the uncertainty it carried disappears. The options no longer need to price the event, so implied volatility falls back towards normal levels, often within minutes of the market opening.

Measuring the expected crush#

Traders estimate the event's share of volatility by comparing expiries before and after the event, or by comparing current implied volatility with typical non event levels. The expected crush is roughly the difference between the event expiry's implied volatility and what it would be without the event. See Earnings Trading.

Expansion in other situations#

Implied volatility also expands outside scheduled events:

• Market selloffs: index volatility jumps as prices fall. See The VIX.
• Unexpected news: takeovers, lawsuits, regulatory actions.
• Contagion: stress in one market spreads to others.

These expansions are less predictable and often larger than event build ups.

Trading around events#

How to avoid the crush trap#

• Compare the implied move with past moves for the same company or event type.
• Use spreads instead of single options for directional event bets, since the short leg offsets much of the vega. See Vega.
• Buy options after the event if you want directional exposure without paying for event volatility.
• Check the term structure to see how much is priced into the event expiry.

Common mistakes#

• Buying calls before earnings without realising how much volatility is priced in.
• Selling event volatility with too much size, since occasional big surprises can wipe out many wins.
• Assuming crush is guaranteed: if the move is large, implied volatility can stay elevated.

Frequently asked questions#

What is volatility crush?#

The sharp drop in implied volatility after an event such as an earnings report, once the uncertainty has been resolved.

Why do my options lose value after earnings even when I am right?#

Because the fall in implied volatility reduces option prices, and if the stock moves less than the implied move, that loss outweighs the gain from the move.

How can I trade earnings without volatility crush?#

Use spreads that reduce vega exposure, trade the stock after the announcement, or sell volatility if you expect a smaller move than implied.

Next, learn to trade the shape of the smile in Skew Trading.