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We usually see a volatility crush begin after big scheduled events like quarterly earnings reports… or a presidential election. In the past month, we’ve had both — setting up an opportunity to trade a big postelection volatility crush.
A volatility crush happens when an option’s price suddenly plummets because investors expect the underlying stock will perform poorly. If you trade options, learning how this complex concept works can save you a lot of money — and sorrow in the long run.
Volatility crushes are caused by fast, sharp drops in implied volatility that prompt a similar fall in options values. Implied volatility is like a forecast of an option’s potential value, so the higher implied volatility is, the higher the option’s price will be. On the other hand, when implied volatility falls, so does the option’s price.
Let’s say you bought calls on a stock and it’s up 2% today. Chances are those call options are going to be flat or down in value… which you wouldn’t expect since technically the stock is up, so the price should be, too.
That’s volatility crush in a nutshell.
Understanding a postelection volatility crush is like finding a needle in a haystack: You know it’s there, but uncovering it won’t be straightforward… or easy.
We’re now one day out from the election, and Tuesday morning we saw the S&P 500 up 1.5% premarket and the Nasdaq up about 3%. Meanwhile, the VIX was down 12%.
Why is that?
Basically the market makers (the guys and gals controlling the options market) assumed the Nasdaq would move 5% and the S&P 4.5% higher or lower by Friday. Being up only 1.5% is next to nothing.
So what’s going to end up happening is that the price of the options — not only the indexes but in the individual stocks — is going to dwindle down in value unless they meet and exceed the market makers’ expectations.
Watch today’s video to find out what you should expect this week and let me know your thoughts! Have you ever traded during a postelection volatility crush? If so, how did things go? I’d love to hear what you think in the comments below.
P.S. After trading the post-election volatility crush, make sure to check out these millionaires (all still under 55!) who opened up the holy grail of stock trading tips.
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