Implied vs. Historical Volatility: Understanding Volatility Crush

Category : Implied vs. Historical Volatility | Sub Category : Volatility Crush Posted on 2023-07-07 21:24:53

Implied vs. Historical Volatility: Understanding Volatility Crush
Introduction:
The world of finance and investing has a certain amount of variability. It is a measure of the degree of price change in a financial instrument. Is implied volatility and historical volatility are two types of volatility that traders and investors analyze. In this post, we will discuss the phenomenon known as "volatility crush" and the differences between the two volatility measurement.
Understandingmplied volatility is important.
The market's expectations of future price movements are reflected inmplied volatility. The market's consensus on the potential range of a security's future price is derived from options prices. Implied volatility takes into account a number of factors, such as supply and demand dynamics, market sentiment, and upcoming news or events that may impact the security.
Historical volatility.
Historical volatility is a measure of the price movements of a security. The standard deviation of price returns is calculated using historical data. Historical volatility is a measure that allows investors to see how the price of a security has changed over time.
The crush of volatility.
A significant decrease in implied volatility is called a "volley crush". It is most often observed in the options markets, where the implied volatility of an option affects the price. The market tends to reduce the premium associated with options when expectations for future price movements are not as high.
There are reasons for the volatility crush.
There are several reasons why volatility crush may occur.
1 Companies experience heightened volatility leading up to earnings releases as investors anticipate potential surprises. The uncertainty decreases after the earnings report is released.
2 The announcement of a merger or acquisition can cause significant uncertainty and volatility in the markets. As the transaction progresses, implied volatility tends to decline.
3 Government policy decisions can have a profound impact on market volatility. Ismplied volatility decreases once decisions are made and understood.
There are trading strategies and volatility crush.
Specific strategies can be used to take advantage of volatility crush. There are two popular strategies.
1 Long options trades are done to benefit from an increase in implied volatility. If the expected event does not lead to significant price movements, the implied volatility will crush, causing options prices to decrease.
2 Short straddles are where traders sell a call option and put option with the same strike price and expiration date. They expect the underlying security to stay within a certain range, which in turn will cause a decline in implied volatility and erode the value of the options they sold.
Conclusion
Understanding the difference between implied and historical volatility is important for traders and investors. Historical volatility reflects past price fluctuations while implied volatility is market expectations for future price movements. The phenomenon of volatility crush can be exploited through various trading strategies. By recognizing the factors that contribute to volatility crush, traders can make informed decisions and potentially profit from changes in implied volatility.