what's IV crush and how to take advantage of it
**Understanding IV Crush and Strategies to Capitalize on It**
In the world of options trading, few terms are as critical to understand as "IV Crush." IV, or Implied Volatility, is a metric that reflects the market's forecast of a likely movement in a security's price. An IV Crush occurs when there's a sharp decline in implied volatility, which typically happens after a significant event like an earnings report. This sudden drop can significantly affect the extrinsic value of options contracts, often to the detriment of uninformed traders¹.
**What Causes an IV Crush?**
An IV Crush is usually event-driven. Before a major event, there's a lot of uncertainty about the future price of a stock, which inflates the option premiums due to higher implied volatility. Once the event passes and the uncertainty resolves, implied volatility plummets, and so does the extrinsic value of the options—hence the term "crush."
Events can be like upcoming earnings, central bank announcements like fomc, interest rate decisions or cpi reporting.
**Strategies to Take Advantage of IV Crush**
One popular strategy to take advantage of an IV Crush is the **Strangle**. A strangle involves purchasing both a call and a put option with the same expiration date but different strike prices. The idea is to profit from a significant price move in either direction. Here's how it works:
- **Long Strangle**: You buy an out-of-the-money (OTM) call and an OTM put. This strategy has a high profit potential if the underlying asset experiences a significant price movement, regardless of the direction.
- **Short Strangle**: Conversely, you sell an OTM call and an OTM put. This strategy is profitable if the underlying asset's price remains within a certain range, limiting the profit to the premiums received for selling the options⁶.
**Implementing a Strangle Strategy**
To implement a strangle, traders should look for situations where they expect a significant move in the underlying asset's price but are uncertain of the direction. This could be before an earnings announcement or a product launch. The key is to anticipate the IV Crush and set up the strangle beforehand.
**Example of a Long Strangle**
Let's say a company is about to release its earnings report, and you expect a big move in its stock price but are unsure which way it will go. You could set up a long strangle by buying both a call and a put option with strike prices on either side of the current stock price. If the stock moves significantly in either direction, one of your options will become profitable enough to not only cover the cost of both options but also provide additional profit.
Before you do this, also learn how to defend a strangle position.
**Conclusion**
IV Crush can be a daunting phenomenon for options traders, but with the right strategies, it can also present unique opportunities. Strangles are just one of the many strategies traders can use to turn the tables on IV Crush. By understanding the mechanics of implied volatility and the impact of market events, traders can position themselves to capitalize on the volatility rather than fall victim to it. Remember, successful options trading requires a blend of knowledge, timing, and strategic execution.
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