Theoretically, an options crush can impact a single option, or it can impact a group of options. Some hypothetical examples of earnings crushes are outlined below.
Imagine, for example, that hypothetical stock XYZ has earnings in mid-September. Leading up to an earnings event, the implied volatility of the expiration month that captures the earnings event usually experiences a spike in implied volatility. In this example, that would be the monthly options for September, as well as any weekly options that capture the event. In the wake of earnings, the implied volatility of those options often drop back to “normal” levels, or even lower. That abrupt decline in implied volatility represents the post-earnings IV crush.
Looking at another hypothetical example, imagine that new legislation has been proposed that would drastically reduce the profitability of the biotech sector.
In this case, the implied volatility of options exposed to the biotech sector (stocks and ETFs) would likely rise. Especially for those options that specifically capture the event. For example, if Congress was scheduled to vote on the legislation in early February, this hypothetical scenario would likely push up the implied volatility of the sector for monthly and weekly options that encompass the vote. And for these options, volatility would almost certainly decline in the wake of the event, much like after a company report’s earnings.
To track implied volatility, and potential volatility spikes and ensuing crushes, investors and traders can use metrics like Implied Volatility Rank (aka IV Rank). IV Rank reports the current level of implied volatility in a given underlying (stock or ETF) against the last 52 weeks of data.
As a result, IV Rank allows investors and traders to quickly filter for opportunities where implied volatility is trading at an extreme. For example, the upper or lower end of the 52-week range. Options traders prefer to trade volatility at extremes because volatility is historically mean-reverting.
In terms of interpreting IV Rank, this metric is expressed as a value between 0 and 100%. For example, if implied volatility in hypothetical stock XYZ is trading at 50, and the 52-week range in implied volatility is between 25 and 75, that would indicate an IV Rank of 50%.
On the other hand, if implied volatility was trading at 25 in hypothetical stock XYZ, then IV Rank would be 0%, because 25 represents the lowest level of implied volatility observed over the last 52 weeks. Alternatively, if implied volatility was trading at 75, that would represent an IV Rank of 100%, because 75 represents the highest level of implied volatility observed over the last 52 weeks.
When IV Rank is above 50%, options traders typically look for opportunities to sell volatility. This is especially true when the VIX is trading at elevated levels. The long-term average in the VIX is roughly 19.
So when the VIX starts trending into the 20s and 30s, options traders usually get more active selling derivatives. On the flip side, volatility-focused traders tend to look for buying opportunities when the VIX - and IV Ranks - are depressed. This may be represented by a depressed IV Rank, or a low absolute value in the VIX.
One thing options traders have to keep in mind, however, is the existence of “time decay.” As time passes, options lose value, because they draw closer to expiration. And that natural headwind can work against options buyers.