In this post, I want to cover some of the risks behind buying options with a high volatility. A strategy that many traders use (maybe knowingly or unknowingly), but not one I would recommend, especially for beginners.
A call option means you are bullish on the stock and a put option means you are bearish on the stock. Stocks can naturally move up and down on their own depending on certain market conditions, and under those natural market conditions you can trade options and make a nice profit.
The expression “implied volatility crush” or “IV crush” refers to a sudden and sharp drop in implied volatility that will trigger a steep decline in an options value. Most times an IV crush will occur after a scheduled event takes place; like a quarterly earnings report, new product launch, or a regulatory decision from the government.
High IV (or Implied Volatility) affects the prices of options and can cause them to swing more than even the underlying stock. Just like it sounds, implied volatility represents how much the market anticipates that a stock will move, or be volatile. A stock with a high IV is expected to jump in price more than a stock with a lower IV over the life of the option.
When buying options that include the period of earnings announcements for the company, you will pay a much higher premium because the high implied volatility is already accounted for. In my opinion there are far too many risks of buying options with high implied volatility already accounted for on the stock. Unfortunately, the risk does not outweigh the reward in most scenarios.
As with stock trading, options are still much safer to invest long term, although you must be careful with time decay. High IV is something all options traders will experience at one point or another, so be aware of its effects.
If you purchase a call option and the market continues to trend down, you can have a lot of risk and lose most if not all the high premium you paid for the option. But, if the market recovers and has a large up day, you can capture a large profit by exercising your option.
