What Is IV Crush?

What Causes IV Crush

Implied volatility into an event can be decomposed into two components: a baseline volatility reflecting the underlying's normal day-to-day movement, and an event premium reflecting the priced uncertainty of the upcoming binary outcome. Before the event, both components are present, inflating IV. The moment the event resolves (earnings released, FOMC statement issued), the event-premium component immediately becomes worthless (it priced uncertainty that no longer exists), and IV drops to baseline.

The drop is mechanical, not behavioral. Even if the stock moves significantly on the event, the IV component pricing future-event uncertainty has fully priced and decayed. The remaining IV reflects only ordinary day-to-day movement, which is much lower than the inflated pre-event level.

Worked Example

Consider a stock trading at $100 the day before earnings. Implied volatility on the front-week ATM straddle reads 80% annualized. Baseline IV outside earnings is around 30%. The 50-vol-point gap is the event premium pricing a roughly ±6-8% expected one-day move.

The next morning earnings beat consensus; stock opens at $103 (within the implied move). After the open:

• ATM IV drops from 80% to 32% within the first hour of trading
• The front-week straddle collapses from $7.40 to $1.85 even though the stock moved 3% in the buyer's nominal direction
• A trader who bought the straddle for $7.40 the day before is down 75% on a successful directional bet

This is IV crush in action. The buyer was right about direction but lost on vol component dominance.

How Pricing Models Capture IV Crush

IV crush is fundamentally a feature of stochastic-volatility models with mean reversion. Different models capture it differently:

• Heston model: the mean-reversion speed parameter kappa (κ) controls how quickly variance reverts to its long-run level theta (θ). Pre-event variance is elevated; post-event variance reverts toward baseline. The Feller condition (2κθ > ν²) constrains parameter calibration but the qualitative IV-crush dynamic is built into Heston's structure.
• Variance-swap pricing decomposition: the variance swap rate from the option chain decomposes additively as baseline + event premium. Pre-event variance swap = baseline + premium; post-event = baseline. The premium is what crushes.
• Jump diffusion with time-dependent jump intensity: Bates models with deterministic jump intensity peaks at known event dates capture earnings IV expansion explicitly. Post-event the jump intensity drops to baseline.
• Black-Scholes: assumes constant volatility and cannot model IV crush directly. To use BS for event-vol pricing, traders manually shift the volatility input pre/post event. This is the operational workaround but it is not a feature of the model itself.
• Local volatility: calibrates exactly to the listed surface but produces unrealistic forward-IV dynamics. LV underprices forward IV crush because it interpolates rather than projecting from a stochastic structure.

The Earnings Vol Cycle

For a typical liquid US single stock with quarterly earnings:

• T-15 to T-5 days: IV begins climbing as event approaches. Front-week IV rises faster than back-month IV (term structure inverts: front > back).
• T-3 to T-1: IV peaks, often 2-3x baseline. Skew may flatten as both put and call demand rise on uncertainty.
• T-0 (event day): IV reaches maximum just before the announcement.
• T+0 (post-event): IV drops 40-60% within the first 30 minutes of the next session. By end of day, IV is often within 10-20% of baseline.
• T+1 to T+3: IV fully reverts to baseline. Term structure renormalizes (back > front).

Operational Implications

• Long premium into earnings is structurally challenging. Even a correct directional bet often loses money because IV crush dominates delta gains for OTM strikes. The break-even move size is often 1.5-2x the implied move, not the implied move itself.
• Short premium into earnings collects the event premium. Iron condors, short strangles, and credit spreads sold the day before earnings collect the inflated premium that crushes overnight. The risk: the directional move can blow through the short strikes. Sizing must account for tail moves, not the mean implied move.
• Calendar spreads short event vol, long baseline vol. A long calendar (short front, long back) profits as front-week IV crushes more than back-month. Term-structure normalization is the dominant P&L driver post-event.
• Pre-earnings IV expansion is not a forecast. The market is not predicting how much the stock will move; it is pricing the event-premium that decays at announcement regardless of the outcome. Treating IV as a probability forecast misreads the option market's actual signal.

Beyond Earnings: IV Crush in Other Events

• FDA approval decisions for biotech stocks: IV inflation similar to or larger than earnings; IV crush is more violent because the binary outcome is more extreme.
• FOMC statements: SPX IV inflates 2-4 vol points into FOMC days and crushes within 30 minutes of the statement. Calendar spreads on SPX FOMC days are a classic IV-crush arbitrage.
• CPI / NFP releases: macro IV expands then crushes on print. SPY shorter-dated options exhibit the cleanest IV-crush pattern around scheduled macro releases.
• Guidance updates and merger announcements: single-stock IV inflates pre-rumor and crushes on confirmation. Often more dramatic than earnings because the binary is more extreme.

Related Concepts

Term Structure · Vol of Vol · Expected Move · Volatility Risk Premium · Volatility Smile

References & Further Reading

• Dubinsky, A., Johannes, M., Kaeck, A., and Seeger, N. J. (2019). "Option Pricing of Earnings Announcement Risks." Review of Financial Studies, 32(2), 646-687. The reference paper on event-vol decomposition.
• Patell, J. M. and Wolfson, M. A. (1979). "Anticipated Information Releases Reflected in Call Option Prices." Journal of Accounting and Economics, 1(2), 117-140. Early empirical work on earnings IV.
• Heston, S. L. (1993). "A Closed-Form Solution for Options with Stochastic Volatility..." RFS. The mean-reversion structure underlying IV-crush dynamics.

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