Trading Earnings & Surviving the IV Crush

The premium you pay has three main drivers. Direction (delta) adds or removes money as the stock moves. Time (theta) removes a little each day. Implied volatility (vega) adds or removes money as expectations change. On result day all three act at once.

Look at the picture. A call is bought for ₹45 before results on a stock at ₹1,500 with the strike at ₹1,500. The stock rises 2 per cent. Delta adds about ₹15. But the IV collapse removes about ₹24. The next morning the call is worth about ₹36, a loss of ₹9 per share, or 20 per cent of the premium. The buyer was right on direction but the market had already priced in a bigger move than 2 per cent.

The crush is not always harmful to the buyer. If the stock had risen 6 per cent or more, delta would have added far more than vega removed, and the buyer could have gained. And it does not always help the seller: a seller who collected a rich premium is exposed to a large loss if the stock gaps well beyond the expected range. Whoever is on the right side depends on how big the real move is compared with what the price already expected.

You can estimate the expected move from the at-the-money straddle. A straddle means buying the call and the put at the same strike. Take the nearest expiry after the event, add the at-the-money call and put premiums, and divide by the stock price.

Example, illustration only: a stock trades at ₹1,500 before results. The ₹1,500 call costs ₹45 and the ₹1,500 put costs ₹45. The straddle costs ₹90. ₹90 divided by ₹1,500 is 6 per cent. The market is pricing a move of about 6 per cent either way. For the buyer of the call to win after the crush, the stock usually needs to move by more than the premium paid plus the loss from IV falling.

A word of caution. Some studies of US stocks have reported that actual earnings moves were smaller than implied moves on average, but results differ by market, stock and period. We have not verified such a study for Indian stocks, and no ratio should be treated as a rule (Needs verification). Even if it were true on average, a single event can go either way.

Sellers can use defined-risk strategies such as an iron condor: sell an out-of-the-money call spread and put spread together. If the stock stays inside the range, the premium shrinks after the crush and the seller keeps most of it. If the stock gaps beyond the range, the loss is limited to the width of the spread less the premium, but that can still be many times the profit.

A short strangle sells an out-of-the-money call and put without protective legs. It earns the most when the crush happens and the stock stays in range, but it has no fixed limit on loss and needs large margin. A gap in either direction can produce a loss much bigger than the premium collected. It is not a beginner strategy.

Buyers who want to limit the crush can use a spread, for example a bull call spread: buy one call and sell a further out-of-the-money call. The IV fall hits both legs, so the effect is smaller. The price of this is a capped profit. A calendar spread sells the near expiry and buys the next one, hoping the near option loses more IV. It can lose if the stock moves far from the strike. Every route has a cost. None removes risk.