An implied volatility (IV) crush refers to a significant decrease in implied volatility, which is the market's expectation of future volatility as reflected in options prices. This decrease in IV leads to a drop in the price of options, especially options that are out of the money (OTM), as their value is predominantly based on extrinsic (time) premiums. 

At-the-money (ATM) options experience a more substantial pointwise impact from IV crush because they contain the highest amount of extrinsic value, influenced by vega (sensitivity to volatility) and theta (time decay). Longer-dated options are particularly sensitive to drops in implied volatility, making them more vulnerable to IV crush.

When Does an IV Crush Happen?

An IV crush typically occurs after significant events that initially caused a spike in implied volatility. Before earnings announcements, options prices typically rise due to increased uncertainty, and afterwards IV drops as the uncertainty dissipates. Similarly, speculation over mergers and acquisitions drives up IV, which then falls once the details are announced or the event passes. In biotech and pharmaceuticals, IV can surge before product launches or FDA decisions and drop once the outcome is known. Major economic reports or central bank announcements also lead to increased volatility, which decreases once the market absorbs the news.

As options approach their expiration date without significant impending events, their implied volatility tends to decrease. Political or geopolitical events can cause spikes in IV, which subsequently drop when uncertainties are resolved. Overall, these fluctuations in IV are driven by the market's anticipation of and reaction to various events, reflecting the balance of risk and uncertainty perceived by investors.

Advanced Strategies to Manage and Profit from IV Crush

Anticipating IV Crush:

Buying Deep OTM Calls: During a major sell-off, buying deep OTM calls can be beneficial. Even though they are made entirely of extrinsic value, they have less total extrinsic value compared to ATM options. If the IV crushes while the underlying price recovers, the impact of the IV crush is minimized.

Volatility Trading: Much of volatility trading involves anticipating IV crush, such as what happens when event volatility (excess IV due to a high-risk situation) gets rushed out of a contract post-event (e.g., earnings).

Hedging Techniques:

Skilled premium sellers, who collect time premium from short options or credit spreads, often write options during IV spikes to take advantage of the subsequent IV crush. However, they must be cautious under the Volatility Trigger™ where heightened realized volatility is expected, making premium selling riskier.

Speculative Call Buying along with a Volatility Crush - TSLA, NVDA, GEM, AMC

The video focuses on an implied volatility (IV) crush in March 2022, where the market shifted to speculative risk-taking. Short-dated call options in stocks like Tesla and Nvidia surged, causing significant price movements and market makers buying stocks. When call buying subsided, prices declined. Despite geopolitical tensions and FOMC announcements, realized short-dated volatility decreased. The expiration of puts reduced volatility but heightened risk if new puts arise. Key levels include the 4600 call wall and the 4510 JP Morgan collar put.

How to Avoid an IV Crush

Risk management is crucial in options trading to avoid losses from an IV crush. Traders may avoid buying options with elevated IV due to impending events, as the risk of IV dropping significantly afterward can lead to losses. Active position management is necessary to ensure that the passing of a key event does not result in a significant loss. Additionally, performing extensive scenario analysis helps understand potential outcomes and risks, allowing traders to make more informed decisions and mitigate the impact of IV crush on their positions.