🌡️Options 3/5 — IV and IV Crush Around Earnings

This is part 3 of 5 of the options course. Here lies one of the most expensive traps for beginners: IV crush around earnings. Many people get the direction right, the stock moves after earnings exactly as they expected — and they still lose money. This part explains why.

Reminder: Options can expire worthless and lose 100% of the premium invested. The numbers are illustrative.

1. What implied volatility (IV) is

IV is a stock's expected "nervousness" — how much movement the market has built into option prices going forward. It isn't history, it's an expectation.

• High IV = the market expects a big move → options are expensive.
• Low IV = the market expects calm → options are cheap.

🌡️ Analogy — a storm forecast. IV is like rain insurance. When the forecaster calls for a storm (earnings in two days), the insurance gets pricier. When the sky is clear and calm, it gets cheaper. You pay for the expectation, not the reality.

2. Why IV rises before earnings

Earnings are a scheduled event with an uncertain outcome. The stock often gaps up or down afterwards. The market knows this uncertainty in advance, so before the announcement it prices the expected big move into options — IV jumps. The closer to the date, the more inflated it is.

➤ Consequence: options bought a few days before earnings are expensive. You pay an above-average premium precisely because a big move is expected.

3. IV crush — what happens right after the announcement

Once the results are out, the uncertainty disappears. The market now knows the numbers. IV instantly "deflates" back to normal — and option prices fall with it. This sharp drop in IV is called IV crush.

🎈 Analogy — a deflated balloon. Before the announcement the option is a balloon of inflated vega exposure. The announcement sticks a pin in it. Even if the stock jumps the right way, the air (IV) escapes the option so fast that the falling premium can drag you into the red.

4. A concrete example — being right and still losing

Stock $100, the day before earnings you buy an OTM call with strike $105. Because of high IV you pay an expensive premium, say $4.

• The results are good, the stock jumps to $106. You were right on direction!
• But IV deflated. The option's intrinsic value is now just $1 ($106 − $105), and the time + volatility value you paid for has vanished.
• The option you paid $4 for is suddenly worth maybe $1.50 → a loss, even though the stock went up.

➤ This is the most common earnings trap: you pay for the expected move in advance (expensive IV), and after the announcement the crush takes more than the stock move itself added.

5. The expected move — what's "already paid for"

From option prices (from IV) you can compute the expected move — the band the stock is likely to land in after earnings (roughly ±1σ, where ~68% of cases fall). When the stock finishes inside the expected move, option buyers typically lose (they paid for more than happened). When it finishes beyond it, they can profit.

🎯 Key idea: the market has already "paid" for the expected move in advance. For the buyer to profit, the actual move must be bigger than the one priced into IV — not merely "right".

6. The two sides of IV crush

• Option buyers before earnings face a double risk: expensive IV at purchase + crush after the announcement. To profit they need a move beyond the expected one.
• Option sellers, by contrast, typically profit from the crush — they collected an inflated premium and IV deflates in their favour after the announcement. Careful: selling before earnings is risky, though — a big surprise move in the stock can cause a loss far larger than the premium collected. A high win rate ≠ safety.

7. How to think about IV (descriptively)

• IV rank / IV percentile show whether today's IV is high or low relative to the stock's own history. Traders watch these regimes: cheap options are usually sought when IV is low, expensive ones sold when IV is high — that's a principle, not an instruction for a specific trade.
• Before a known event (earnings), IV is almost always inflated. If you're buying an option purely for direction, expect a crush after the announcement.
• This is not "buy/sell" advice — it's a description of how options behave around earnings, so you aren't surprised.

8. Takeaways

• IV = expected nervousness, not the past. It rises before earnings and falls sharply after (IV crush).
• Being right on direction isn't enough — you must beat the move already priced into expensive IV.
• A beginner most often loses by buying an expensive option the day before earnings, and the crush takes the profit even when the stock jumps the right way.

➤ In QMA you'll find IV context and the expected move in the Options Hub on the stock detail — so you see whether IV is currently inflated before doing anything.

Next: Part 4 — Assignment and rolling.

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Options can lose 100% of the amount invested. Past results do not guarantee future ones. Consult a licensed advisor before any decision.*