2013issue C0214-23
Earnings-week implied volatility crush and iron condor wings
The archive walks through vega, a July 2012 earnings-week risk graph, and a reverse iron condor reshape. Editorial framing treats that book as a weeks-to-months regime problem: locate implied volatility against its recent historical band, then cut vega for the post-event crush rather than for the headline gap.
- Implied volatility is the pricing-model input that matches the observed option price, while historical volatility is the realized band used to judge whether that input sits high or low.
- Vega is largest at the strike, fades as an option moves deep in the money or farther out of the money, and declines toward zero over the last 18 days to expiration when implied volatility is held constant.
- In the July 2012 illustration, a sharp post-release drop in implied volatility on near-the-money options produced a vega-related loss larger than the directional gain on the long puts.
- Adding short iron condor wings to a long strangle cut position vega and maximum profit, converting the book into a reverse iron condor.
A long strangle as the starting book
A same-expiry long out-of-the-money put and call is a positive-vega, negative-theta book with a limited maximum loss. Vega is the change in option value for a 1% move in implied volatility. It is positive on long options and negative on short options. Theta is the daily time-decay of option value, so a negative-theta book loses value as time passes if other inputs are unchanged.
At expiration the strangle is profitable only if the underlying finishes above the upper strike plus premiums paid or below the lower strike minus premiums paid.
Where vega is large and where it fades
In a worked illustration, a long call priced at 1.50 with implied volatility of 15% and vega of 0.30 revalues to 1.80 if implied volatility rises to 16%. The matching short call revalues to 1.20.
Vega is largest at the strike and shrinks toward zero as the option moves deep in-the-money or farther out-of-the-money. With implied volatility held constant, vega declines each day toward zero over the last 18 days to expiration.
Implied volatility against the historical band
Historical volatility is the annualized standard deviation of log returns from observed prices. Implied volatility is the model input that equates a pricing-model value to the market option price. It is commonly quoted on a 30-day at-the-money basis and can differ across strikes that share an expiration.
The archive workflow compares current implied volatility with the prior three to six months and treats scheduled market and single-name events as inputs that can change the volatility regime.
The July 2012 after-close release
In the weeks before the release, implied volatility had been about 26%, then rose above 36% the day before the announcement. After the July 24, 2012 after-close release, the underlying opened at 574.46 versus a prior close of 600.92, a drop of more than 4%.
Implied volatility then dropped immediately in at-the-money and near-the-money strikes the next day. Deep in-the-money puts saw implied volatility rise after the large price decline. A volatility crush is a sharp drop in implied volatility after an anticipated event, when demand for options falls.
The pre-event risk graph implied about 500 of profit after one-day decay, but the next-day curve had shifted lower to a 97 loss. Between 7/24/12 and 7/26/12, implied volatility fell 9.33 points on the 590 put and 9.84 points on the 630 call. Multiplying each strike vega by that change and by 100 produced an approximate combined vega-related loss of 1113.726, larger than the directional gain on the puts.
Short wings that cut position vega
Adding a short 655 call and a short 585 put to a long 600 put and a long 640 call converted the strangle into a reverse iron condor. Position vega fell from 61.2 to 26.11, and maximum profit fell with it.
An iron condor is a four-strike combination formed by pairing a strangle with short wings. On multi-leg structures such as iron condors, position vega can switch from positive to negative or the reverse as the underlying moves.
Sizing for the crush rather than the gap
Editorial close: the historical workflow locates implied volatility against the recent realized band, then reshapes vega so the earnings-week book is not left as an unhedged positive-vega strangle into the post-event crush.
All readings on this track · 15 readings
- 2003Implied volatility regimes and range-condor context
- 2007Rewriting calendars and iron condors when volatility regimes shift
- 2008Option spreads, mental stops, and volatility regimes
- 2010Index condor overlays and delta repair
- 2010Equal and unequal strike geometry in a four-leg credit book
- 2010Sizing reserves for condors and pair layers
- 2012Iron condor adjustments when a favorite index breaks
- 2013Earnings-week implied volatility crush and iron condor wings
- 2013Iron condors, butterflies, and stops as one risk budget
- 2014Friday expiry as a weekly butterfly and iron-condor laboratory
- 2014A static iron condor is a market-regime overlay, not an expected-value filter
- 2014Weekly option income adjustments with iron condors and butterflies
- 2014Inverted iron-condor payoffs and misplaced reversal candles
- 2017Patient short-volatility income as a written procedure
- 2020A short iron condor is a weeks-to-months range-regime statement