Volatility Crush

Are you just starting your journey into the world of trading? Odds are you'll encounter a wealth of terms that may seem confusing at first. Our mission is to make these concepts accessible and easy to understand. Today, let's delve into the term Volatility Crush – one of those terms that carry significant importance in options trading.

Understanding Volatility Crush

In its simplest form, Volatility Crush refers to a sharp decline in the value of options, particularly after a major news event. This happens because the implied volatility (IV), a factor that influences options pricing, reduces drastically. Implied volatility is often high prior to key events, as these events carry the potential for significant price movements. However, once the event is over, the uncertainty lessens, leading to a drop in IV, and this is what we call the Volatility Crush. If you've bought an option close to such events, you might see its value decline rapidly – even if the underlying stock price hasn't moved greatly.

How Does Volatility Crush Affect your Trading?

In a nutshell, Volatility Crush can be your friend or foe, depending on your position in the market. If you're an option buyer, a volatility crush can see you suffering losses because the value of your options nosedives after the big event. On the other hand, if you are an options seller, you can benefit from a volatility crush as the options you've sold lose value, making it cheaper for you to buy them back.

How to Mitigate the Risk of Volatility Crush?

There are several ways traders tackle the potential threat of a Volatility Crush. One effective way is by avoiding buying options with a high IV, especially ahead of significant events. Another approach is to switch to a 'spread' trading strategy rather than 'naked' buying or selling. In spread trading, you are both buying and selling options, which provides some level of protection against sudden volatility drops.

All in all, understanding the nuances of Volatility Crush is crucial for any options trader. It's a complex subject, certainly, but with knowledge and experience, you can learn to navigate its challenges and use it to your advantage in your trading journey.