Event-Driven Volatility Trades
Event-Driven Volatility Trades
Beyond earnings, numerous scheduled events drive volatility in specific stocks or the broader market. FDA decisions, Fed meetings, economic releases, and product launches create predictable volatility patterns that options traders can exploit. Understanding how IV behaves around these events enables systematic strategies.
Definition and Key Concepts
Types of Volatility Events
| Event Type | Affected Securities | Typical IV Behavior |
|---|---|---|
| Fed meetings | Index options, rate-sensitive stocks | IV rises into meeting, falls after |
| FDA decisions | Biotech/pharma stocks | IV spikes dramatically, collapses post-decision |
| Economic data | Index options, sector ETFs | Modest IV increase, quick resolution |
| Product launches | Individual stocks | Gradual IV rise, post-event decline |
| Elections | Broad market, specific sectors | Extended IV buildup, slow normalization |
Event Volatility vs. Background Volatility
Event volatility is the additional IV premium specifically attributable to the upcoming event. Once the event passes, this premium disappears regardless of the outcome.
Background volatility reflects ongoing market conditions and persists after the event.
Term Structure Distortion
Events create distortions in the volatility term structure. Expirations immediately after the event have elevated IV compared to expirations before or well after the event.
How It Works in Practice
Trading the Fed
Federal Reserve meetings occur eight times per year on scheduled dates. The announcement at 2:00 PM ET often moves markets significantly.
Pre-Fed Strategy (Long Volatility):
- Buy SPY straddles or VIX calls 1-2 weeks before the meeting
- IV typically rises as uncertainty increases
- Sell before the announcement to capture IV expansion
Post-Fed Strategy (Short Volatility):
- After the announcement, IV typically falls
- Sell options or credit spreads
- Capture the volatility crush as uncertainty resolves
Trading FDA Decisions (PDUFA Dates)
FDA Prescription Drug User Fee Act (PDUFA) dates are regulatory decision deadlines. Binary outcomes create extreme IV.
Characteristics:
- IV can exceed 200% before major decisions
- Stock moves of 50-90% are possible
- Implied moves often underestimate actual outcomes
Strategy Considerations:
- Long premium is expensive but can pay off on extreme moves
- Short premium offers high credit but catastrophic loss potential
- Many traders avoid trading these entirely due to binary risk
Trading Economic Releases
Major economic data (jobs reports, CPI, GDP) affect index options and specific sectors.
Employment Report Strategy:
- Report released first Friday of each month at 8:30 AM ET
- SPY options on the immediately expiring weekly see IV elevation
- Consider selling options expiring that day if IV premium seems excessive
Worked Example
Case Study: FOMC Meeting Trade
The Fed announces its decision on Wednesday at 2:00 PM. Current date: Monday, two days before.
Market Conditions:
- SPY at $450
- Wednesday expiration straddle: $8.00 (1.8% implied move)
- Friday expiration straddle: $10.50
- Typical FOMC day move: 1.0%
- Current VIX: 18
Strategy: Short Wednesday Straddle
Trade:
- Sell $450 call for $4.20
- Sell $450 put for $3.80
- Total credit: $8.00
Thesis: Market overprices FOMC moves; 1.8% implied exceeds 1.0% historical average.
Risk Parameters:
- Breakevens: $442 and $458
- Max profit: $800 if SPY closes at $450
- Max loss: Unlimited (short straddle)
Outcome Scenarios:
| SPY at Wed Close | Intrinsic Loss | P/L |
|---|---|---|
| $450 (unchanged) | $0 | +$800 |
| $454 (1% up) | $400 | +$400 |
| $446 (1% down) | $400 | +$400 |
| $460 (2.2% up) | $1,000 | -$200 |
| $440 (2.2% down) | $1,000 | -$200 |
Alternative: Iron Condor for Defined Risk
- Sell $445/$440 put spread for $1.50
- Sell $455/$460 call spread for $1.40
- Total credit: $2.90
- Max loss: $5.00 - $2.90 = $2.10
This defines risk while still betting on contained movement.
Risks, Limitations, and Tradeoffs
Binary Outcomes
Many events have binary outcomes that can overwhelm any premium collected. An unexpected Fed action, surprise FDA rejection, or shock economic data can move markets multiple times the implied move.
Timing Precision
Event trading requires precise timing. Enter too early and theta decay erodes value. Enter after the event and the opportunity has passed.
Liquidity Around Events
Bid-ask spreads often widen before major events as market makers hedge their own exposure. Execution quality may suffer.
Overnight Gap Risk
Many events occur outside regular trading hours. You cannot adjust positions during the announcement, making gap risk unavoidable.
Common Pitfalls
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Underestimating tail risk: Rare extreme outcomes can devastate short premium positions.
-
Overweighting historical averages: Past moves don't predict future moves; circumstances change.
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Ignoring event date precision: A PDUFA date is a deadline, not a guarantee—FDA can decide earlier.
-
Overleveraging event trades: Binary outcomes mean sizing must account for complete loss scenarios.
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Trading too many events: Each event carries unique risks; spreading attention thin reduces edge.
Checklist for Event-Driven Trades
- Identify the exact date and time of the event
- Calculate implied move from ATM straddle
- Compare implied move to historical moves for similar events
- Assess whether IV is elevated relative to normal levels
- Choose between long volatility (expect big move) or short volatility (expect small move)
- Size position for potential maximum loss
- Consider defined-risk alternatives to naked short positions
- Plan for both gap scenarios (favorable and unfavorable)
- Set exit rules for post-event management
Next Steps
Ratio spreads offer asymmetric exposure that can be useful around events. See Ratio Spreads and Backspreads for structures with unbalanced legs.
For earnings-specific event trading, review Earnings Season Options Playbooks.