Lesson Overview

Earnings IV Crush

Before you start making earnings trades it's important to understand the "why" behind what we do. In general, we make earnings trades to potentially profit from an IV crash that happens following the company's announcement.

Before a company announces earnings you will generally see the implied volatility of its options increase as the one-time binary event draws closer. After the event has occurred, there is less fear or unknown in the market and therefore implied volatility will drop quickly for the underlying options.

As traders we can tailor specific options strategies to profit from this one time event in any stock. In this video we’ll show you some examples to prove the IV crush theory.

More Discussion

Was This Helpful? Add Comments/Questions

  • Mookie S

    Nice summary.

  • Steve

    It would seem to me that the customary pricing guidelines of credit = %ITM x spread would likely be relaxed in the case of earnings trades? Since they are so short term. Or should I be sticking to that on earnings trades too?

    • Correct – it’s more about getting beyond the expected move.

  • Good question – my answer is that you don’t know where a stock will open so it’s best to always play it neutral. Even stocks that look like they are “trending” can gap higher or lower against the trend.

  • Yeah they do a bad job of not showing it unfortunately.

  • Brian

    Hi Kirk, Great Video as always! Can you expand how it is possible for IV to go down dramatically while the stock price is making a major move. Isn’t volatility, by definition, wide swings in the stock price? Thanks!

    • Implied volatility is the expectation of swings – once the unknown event has arrived (earnings) the move is just a reaction but we don’t expect further but swing because, well, it already happened.

      • Brian

        Gotcha, thanks!

Show Video Transcript +

Today, I wanted to show you guys and prove the implied volatility crush that we see when we talk about trades around earnings.

And we’re going to look at BBBY (that’s three Bs) which is Bed Bath & Beyond because Bed Bath & Beyond honestly presents one of the best cases for implied volatility crush. We see one of the most dramatic drops in implied volatility right after Bed Bath & Beyond announces earnings.

This is a chart of the last two years of trading for Bed Bath & Beyond, and you can see down here on the bottom section of the chart, this is implied volatility tracked along with the stocks. We have the stock up above, but down here below in green, this is that implied volatility that we’re tracking.

Now, what's important to notice about this is that we have such dramatic moves in implied volatility. And we say it all the time. We have to be on the right side of volatility.

Well, now we can visually see when it comes to earnings that the right way to trade earnings is to trade earnings with an implied volatility move down.

And we can visually see this because I’ve overlaid on this chart the actual earnings announcement every single time that Bed Bad & Beyond has earnings. You can see here that implied volatility drops sharply after that earnings announcement or the day of that earnings announcement.

Now that we see this on a chart, this gives us an opportunity as traders to make a very, very targeted high probability trade. And all I want to do on this video is just focus on that drop in implied volatility.

Now, just because the stock has a big drop in implied volatility, most people assume that that also correlate sometimes with a big move in the stock after earnings. And in the case of Bed Bath & Beyond, sometimes that is the case as we’ll see here in a second, sometimes it's not.

In the case of a couple of times back before in March and April of last year and then again in June of last year, you’ll see that the stock had earnings, and we saw that big drop in implied volatility, but the stock went nowhere after the market.

Most people with earnings try to play the market by entering a long position, so buying options on either end and assuming a huge move. But the better strategy, the more profitable strategy long-term is to play this by selling options around the stock the day before earnings and taking advantage of just that implied volatility move.

And you can see we probably were able to take advantage of this a couple of times before in the past even with a little gap here and there with the stock because implied volatility dropped so sharply after earnings that it enabled us to sell option premium and take a profit.

Now, obviously we’re going to have situations like we had at the beginning of last year with BBBY which we weren’t part of this trade, thank God, but some people were in and implied volatility dropped and the stock dropped.

And this goes to show you because another common myth is that if a stock has a big move lower and gaps lower, most people would assume that implied volatility would rise at that point.

You’ll hear a lot of traders that’ll say implied volatility will rise as stocks fall. Well, in this case, the stock dropped almost $10 which is a huge move lower and implied volatility still got cut more than 50%.

It was a big drop in implied volatility, and the stock fell by more than $10, totally goes against the grain, but this is actually what happens. When you get in here and start looking at the charts, you can see what happens and why we should be trading one strategy over another.

Hopefully, in this video, you saw the power of the implied volatility crush that happens after earnings trades. I encourage you to go through a lot of different securities that are out there and look at the history of that drop in implied volatility that they have after or right before earnings for a lot of the stocks that you’ll end up trading!

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