September Office Hours FAQs: Volatility Crush, Assignment Risk and Vertical Spreads

If implied volatility is high, does that automatically mean options are expensive?

Not on its own. Implied volatility is a number that moves option prices up or down, but the number by itself doesn't say much. The real question is: compared with what? One common comparison is historical volatility, which measures how much a stock has actually moved in the past. Historical volatility looks backward, while implied volatility looks forward, forecasting how much a stock is expected to move before the option expires. Comparing the two can help a trader judge whether today's implied volatility looks rich or cheap relative to how the stock has actually behaved.

What's the difference between IV rank and IV percentile, and why check both?

Both compare today's implied volatility with where it has traded over roughly the past year, but they measure it differently. IV rank places today's level between the highest and lowest readings in that period. IV percentile instead counts what percentage of days had a lower reading than today. A single unusually high or low day can skew IV rank, since it only looks at the top and bottom of the range. IV percentile is less affected by one outlier, which is why many traders look at both figures together rather than relying on just one.

What is "volatility crush," and why can a trade lose money even when the stock moves as expected?

Implied volatility tends to climb heading into a known event, like an earnings report, because of uncertainty about the outcome. That rising volatility pushes option prices higher. Once the news is out, the uncertainty is gone, so implied volatility often drops quickly, a move known as volatility crush. Since an option's price depends on both the stock's direction and its implied volatility, a sharp drop in volatility can offset some, or all, of the gain from being right about which way the stock moved.

Is there a way to predict whether, or when, a short option will be assigned?

No. Assignment is a random process. When an option holder exercises, the Options Clearing Corporation assigns that exercise to one of its clearing members holding the matching short position, without knowing anything about that member's specific contract, price or number of days remaining. Exercise and assignment notices are only processed after the market closes, once the day's trades are settled, so nothing can be assigned during trading hours.

If a short option in a spread gets assigned, is there still time to manage the other leg?

Generally, no. Exercise notices are processed before assignment notices each night, and by the time a trader learns of an assignment, the window to exercise a paired long option for that session has usually already closed. That's one reason many traders close a short option ahead of the market close if they want to avoid assignment altogether, rather than waiting to react to a notice the next morning.

Can an option be assigned at any point during its life, or only at expiration?

It depends on the style of the option. American-style options, which cover most individual stocks, can be exercised at any point up to expiration, so a short position in one carries assignment risk throughout its life. European-style options, which cover most broad-based index products, can only be exercised at expiration. The only way to remove assignment risk on a short American-style option before expiration is to buy to close the position.

Why would someone exercise an option early instead of waiting until expiration?

Early exercise is uncommon but does happen. One case involves dividends: a trader holding a deep in-the-money call may exercise it early to capture an upcoming dividend if the option's remaining extrinsic value is smaller than that dividend payment. A rough way to estimate that extrinsic value is to check the price of the matching put at the same strike, since the two tend to be close. On the put side, some traders exercise early to create a short stock position that earns interest, rather than for a dividend-related reason. If the interest to be received from being short the stock exceeds the extrinsic value in the put then that put is a candidate to be exercised early.

What does it mean when an option is "trading at parity"?

Parity means an in-the-money option's price matches its intrinsic value exactly, the difference between the stock price and the strike price, with no extrinsic value left. As an in-the-money option gets closer to expiration, it increasingly trades close to that intrinsic value, since there's less time left for it to be worth anything more.

Is there an advantage to buying a deeper in-the-money vertical spread instead of one further out-of-the-money?

It comes down to a trade-off between cost and likelihood. A deeper in-the-money call spread costs more upfront, but it's more likely that both legs finish in-the-money, letting the trader capture the spread's full value. A further out-of-the-money spread costs less and offers a larger potential return relative to that cost, but has a lower likelihood of both legs finishing in-the-money. Neither choice is inherently better; it depends on how much a trader is willing to pay for a higher likelihood of success versus a larger potential payoff.