Why IV Changes During Earnings Season

Key Concepts:

• Volatility Crush
• Implied Volatility Expansion
• Earnings Event
• Selling Volatility
• Options (Calls and Puts)

Volatility Crush as a Trading Strategy

The primary reason for trading earnings at Tastytrade is the phenomenon known as "volatility crush." This strategy capitalizes on the predictable behavior of implied volatility surrounding earnings releases.

Implied Volatility Expansion Pre-Earnings

Heading into an earnings event, it is highly reliable that implied volatility will expand. This means that the price of options, both calls and puts, tends to increase on both sides of the market. This expansion is driven by the uncertainty and potential for significant price movement associated with the earnings announcement.

Selling Volatility Post-Earnings

The core of the volatility crush strategy involves selling volatility just before the earnings release. By waiting until the end, immediately preceding the announcement, traders can sell options at inflated prices due to the expanded implied volatility.

The Impending Volatility Crush

Once the earnings number is released, a significant "volatility crush" is almost certain to occur. This refers to the rapid and substantial decline in implied volatility after the uncertainty of the earnings announcement is resolved. The market can then price in a more stable expectation, leading to a decrease in option premiums.

Taking Advantage of the Crush

By selling volatility (i.e., selling options) before the earnings release, traders position themselves to profit from this subsequent decline in implied volatility. As volatility crushes, the value of the sold options decreases, allowing the seller to buy them back at a lower price or for them to expire worthless, thus realizing a profit.

Synthesis/Conclusion

The volatility crush strategy leverages the predictable expansion of implied volatility leading up to earnings announcements and the subsequent sharp contraction of that volatility once the earnings are released. By selling options just before the event, traders can profit from the decrease in option premiums as uncertainty dissipates.