The Rush and the Crush
In this situation, volatility rises before and falls after a widely anticipated
news announcement, of earnings, for instance, or of a Food and Drug
Administration (FDA) approval. In this situation, option buyers rush in and
bid up IV. The more uncertainty—the more demand for insurance—the
higher vol rises. When the event finally occurs and the move takes place or
doesn’t, volatility gets crushed. The crush occurs when volatility falls very
sharply—sometimes 10 points, 20 points, or more—in minutes. Traders
with large vega positions appreciate the appropriateness of the term crush
all too well. Volatility traders also affectionately refer to this sudden drop in
IV by saying that volatility has gotten “whacked.”
In order to have a feel for whether implied volatility is high or low for a
particular stock, you need to know where it’s been. It’s helpful to have an
idea of where realized volatility is and has been, too. To be sure, one
analysis cannot be entirely separate from the other. Studying both implied
and realized volatility and how they relate is essential to seeing the big
picture.