IV crush refers to the Implied Volatility (IV) of an options contract that falls sharply after news or an event release. It typically happens when there is a significant move in the underlying asset price, and market participants had expected a more substantial move than what occurs.
Why does IV Crush happen in Hong Kong?
One reason is that due to the time difference between Hong Kong and other major financial centres such as London and New York, news released during Hong Kong’s trading hours may have already been priced in by the time traders in Hong Kong start trading. It often causes prices to move less than what was initially expected.
Lack of liquidity
Another reason is that the Hong Kong market is often less liquid than other markets, so when there is a significant move in price, there may not be enough buyers or sellers to absorb all the contracts being traded. It can exacerbate the price move and cause IVs to fall sharply.
Different trading strategies
Different trading strategies employed by participants in Hong Kong can also contribute to IV crush. For example, many traders here use short-term strategies such as day trading or scalping, which means they are more likely to close out their positions quickly after a news release. It can lead to a sharp drop in IV as fewer contracts are left outstanding.
Futures and options expiration
Futures and options expiration also play a role in IV crush. Traders often need to buy or sell the underlying asset when contracts expire to close out their positions. It can create a lot of buying or selling pressure, which can move prices sharply and cause IV to drop.
How does IV Crush impact traders?
IV crush can significantly impact traders, especially those who are long or short options.
If you are long on an option, a sudden drop in IV can erode the value of your position as the time premium declines. When IV falls, the market expects less price movement in the future.
If you are short on an option, a sudden drop in IV can increase the value of your position as the time premium declines. When IV falls, it means that the market is expecting less price movement in the future.
Therefore, it is vital for traders to be aware of the potential for IV crush and to manage their positions accordingly.
What are some things traders can do to avoid or mitigate the impact of IV Crush?
Use stop-loss orders
Stop-losses are designed to limit losses on a position by automatically selling the asset when it reaches a specific price. It can help traders avoid or mitigate the impact of IV crush.
Use limit orders
Limit orders are designed to protect profits on a position by automatically selling the asset when it reaches a specific price.
Manage position size
Position size is the number of contracts or shares that you trade. Managing position size can help traders avoid or mitigate the impact of IV crush.
Wait for the dust to settle
After a news release or event, it can take some time for the markets to adjust and IV to settle down. Therefore, it may be wise for traders to wait for the dust to settle before entering into or exiting from positions.
What are the benefits of an IV crush in Hong Kong trading?
Provides opportunities to enter or exit positions
IV crush can provide opportunities for traders to enter or exit positions. For example, a trader who is long an option may be able to sell their position at a higher price if the IV falls sharply.
Creates opportunities for arbitrage
Arbitrage is the process of taking advantage of price differences in different markets. For example, a trader might buy an asset in one market and sell it in another market where the price is higher. IV crush can create opportunities for arbitrage as prices adjust across different markets.
Increases market activity
IV crush often leads to increased market activity as traders take advantage of the opportunity to enter or exit positions. It can lead to more liquidity and better prices for traders.
Get started trading in Hong Kong
If you want to start trading in Hong Kong, you can create an account with Saxo capital markets.