Earnings calendars and IV crush

The fundamentals course showed IV crush from the buyer's side: a long straddle through earnings loses even when the stock moves, because the implied volatility that priced it collapses the next morning. A calendar is the standard way to be on the other side of that crush without taking on unlimited risk. It works when the move is smaller than implied. It does not work when the move is larger, and the market is right about the size of the move more often than earnings-calendar traders like to admit.

The setup

XYZ at $50, earnings after the close in five days. The term structure is sharply inverted, as it always is before an event:

Sell the 7-day $50 call, buy the 35-day $50 call. Debit $0.60. The front straddle (call plus put, about $4.40) says the market expects a move of about ±$4.40, or ±8.8%, by the front expiration, almost all of it on the earnings night.

After the event

Earnings pass. The front month's IV collapses toward the stock's ordinary level, the back month's IV falls from 45% to about 32% (it also contained the event, and now it does not). Evaluate at the front expiration, seven days after entry, with the back call at 28 days and IV 32%:

Max profit about $1.16, nearly twice the debit, if the stock does not move. Breakevens near $47.10 and $53.40: the calendar makes money if the move is inside roughly ±$3, and loses if it is larger. The market implied ±$4.40. So the trade is a bet that the realized move is smaller than about 70% of the implied move. Max loss is the $0.60 debit, reached only on a very large gap.

Earnings calendar, P&L at front expiry vs. size of move

  +116 |            /\
       |          /    \
    0  |--------X--------X--------    X = 47.10 / 53.40
       |      /            \          implied move: 45.60 / 54.40
   -60 |___/                  \___
       +---+---+---+---+---+---+---+
       44  46  48  50  52  54  56    XYZ

The two things that have to go right

1. The move has to be smaller than implied. Historically, stocks move less than the implied earnings move somewhat more often than not; that is the same volatility risk premium as everywhere else, and the reason the calendar is not a coin flip. It is also not a strong edge. Something like a third of earnings reports produce a move larger than implied, and the calendar's profit zone (±$3) is tighter than the implied zone (±$4.40), so the actual win rate is nearer 50–60% than the "IV always crushes" story suggests.

2. The back month has to hold enough value. The table assumed the back month's IV fell to 32%. It is the calendar's long leg, and it is crushed too, just less. If the back month fell harder, to 26%, the back call would be worth about $1.44 at $50 and the max profit would be $0.84 instead of $1.16. If, unusually, the back month held at 40%, it would be worth about $2.20 and the profit would be $1.60. The trade is long the back month's IV whether you think about it or not.

Practical notes

• Close the morning after. Most traders exit at the open after the report rather than holding the front to expiration. The front call still has a little time value at that point (with six days left and IV back to 30% it is worth about $0.75 at the money), so the realized profit is smaller than the table, about $0.45 per share in the unchanged case, but you skip the final week's gamma and can redeploy.
• Double calendars widen the tent. A put calendar below the price plus a call calendar above it produces a flatter, wider profit zone at the cost of two debits. It fits when you expect a modest move but do not know the direction.
• Same-strike, not same-price. The structure needs the same strike in both months. Using different strikes makes it a diagonal (next lesson), which adds direction.
• Check the back month for its own event. If the monthly expiration contains a second catalyst (a product launch, an index rebalance), its IV will not crush the way you expect.
• Liquidity matters twice. Weekly options on smaller names can have wide markets before earnings; the calendar pays that spread on entry and exit.

Key idea: An earnings calendar sells the event-inflated front month and buys the back month at the same strike; it profits when the realized move is smaller than about 70% of the implied move and the back month's IV holds up. It is a defined-risk way to sell the crush, with a win rate closer to a coin flip than the crush story implies.

Try it: Find a stock reporting in the next week. Record the front and back-month IV and the front straddle price; compute the implied move. Build the ATM calendar and record the debit and breakevens. After the report, compare the actual move to the implied move and note the calendar's P&L at the open.

Recap

• Before earnings the term structure inverts: front IV 80%, back IV 45% in the example, and the front straddle prices the expected move (±$4.40).
• The calendar's profit zone is narrower than the implied move: about ±$3 here, breakevens $47.10 and $53.40.
• Max loss is the debit; max profit near 2× the debit if the stock sits still and the back month's IV crushes only moderately.
• The back month is crushed too; the trade is long its IV.
• Close the morning after; realized profit is smaller than the expiration table but avoids the final week's gamma.