Buying options is a whole different ballgame compared to buying stocks, in part because of the time value component of an option's price. Whereas a vanilla stock trader simply needs to be right on the direction of the stock's price, an options buyer needs that expected stock move to play out within a fixed period of time -- and that move needs to be substantial enough to offset the negative impact of time decay on the option's value.

Implied volatility (IV) is a key component of time value, and it reflects the market's expectations for how much volatility the stock will realize over the life span of the option. Internally, we use a metric called the Schaeffer's Volatility Scorecard (SVS) to help us identify stocks that regularly make bigger price moves than their options IV levels would suggest. 

SVS works by measuring a stock's realized volatility against the volatility expectations priced into that stock's at-the-money options over the past year. As such, it helps identify which stocks historically have been the best -- and worst -- for premium buyers.

T he Schaeffer's Volatility Scorecard (SVS) is calculated by analyzing straddle returns over the past year (252 trading days). The straddle prices are calculated daily from hypothetical options that are exactly at-the-money and expire in exactly the holding period selected (one week or one month). We derive option prices using implied volatilities from actual options that closely match the hypothetical ones in terms of strike and expiration. The return data from these hypothetical straddles is then compared across all tickers, resulting in a score from 0 to 100. The top 20 stocks with a score of 99 or 100 are below.

Due to instances where options do not trade or bid/ask spreads are too wide, most stocks do not have returns for all 252 days. These 250 hypothetical straddle returns per stock for each year are used to calculate the SVS value, which considers three weighted criteria: 40% is based on the average straddle return; 40% is based on the percentage of positive returns; and 20% is based on the percentage rank of the straddle IVs. These metrics are then combined into a score ranging from zero to 100. 

High SVS readings (up to 100) indicate that a stock has consistently delivered bigger returns than its options IV levels have predicted, meaning it may be a strong candidate for premium-buying strategies going forward, as well. Low SVS readings (all the way down to zero) point to stocks that have consistently realized lower volatility than their options have priced in -- pointing to possible premium-selling candidates.

It's important to remember, though, that the SVS is not necessarily predictive of future outcomes, given that it's a lagging indicator. Instead, we look at the SVS alongside coincident volatility indicators -- such as 30-day at-the-money IVs and the term structure as a whole -- and combine that analysis with our usual technical and sentiment-driven critiques to pinpoint the strongest possible stocks for option-buying opportunities.

To learn more about identifying options trades, check out this primer on implied volatility. To get ready for earnings season, be sure to read about this options strategy.

Subscribers to the February edition of Schaeffer's Option Advisor received this educational excerpt earlier today. But because its so helpful in understanding options basics and strategy, we're going to repost it below!

Learn to Trade Options: Stock Prices and ‘Magnetic’ Open Interest

Options trading can be tricky, and anticipating which stocks will move in what direction can seem like witchcraft to those who don't know what to look for. Options players are always on the lookout for clues about where and how to invest, and the best options traders know where to look for data that can help them rake in the wins. One of the more subtle, and perhaps underappreciated, factors that can help a derivatives trader anticipate the movement of an underlying security is its open interest.

What Is Open Interest?

Open interest is the total number of open contracts for a particular option series. Until a contract is bought or sold to close, exercised, or expired, it remains counted as part of an option's "open interest."

It's very common to find major put open interest concentrated at levels either at or below the stock's current price -- i.e., at-the-money (ATM) or out-of-the-money (OOTM) strikes. This is especially true of some of the broader equity-based exchange-traded funds (ETFs) that have gained popularity among stock traders looking for a hedge, such as the SPDR S&P 500 ETF Trust (SPY) and iShares Russell 2000 ETF (IWM).

What Does Open Interest Tell Traders?

Heavy build-up of open interest can occur at important technical levels, can affect the stock's near-term trajectory, and often provides clues into the collective sentiment towards a stock. In general, we consider a "significant" amount of put open interest to be roughly equivalent to 10% of the stock's average daily volume, concentrated at a particular strike level.

From a sentiment perspective, a massive amount of put open interest at a particular price point is indicative of climactic pessimism, which we would expect to coincide with the exhaustion of selling pressure. Once the stock attains this anticipated "bottom," it then takes relatively little buying power for the shares to stage a reversal.

On the technical side, as a stock approaches a price level with a large amount of open put interest, put sellers may engage in hedging action to manage risk exposure. Option sellers may buy shares to hedge their current position or cover their "naked" options, thus boosting the stock's price and keeping their puts in the money.

On the contrary, if the put-heavy strike is out-of-the-money -- perhaps attractive to shareholders seeking an options hedge to protect paper profits -- the put strike can actually work as a "magnet" to draw the price down as expiration nears. This is because the option will become more sensitive as the underlying security declines, and put sellers will be more motivated to hedge their sold puts with an increase of shorting activity. This "delta hedging" further drives down the price, which in turn necessitates more hedging.

Eventually, the fully hedged put strike price could create a support level, assuming there is not another "magnet" to draw prices down even further.

While such put support has really taken center stage, especially in recent years, there is still a flip side to this scenario of options-related support. Strikes at which there is heavy out-of-the-money call open interest potentially represent resistance. Those who sold the calls have a vested interest in seeing the stock remain below the key strike, and may induce resistance by adding selling pressure when the stock approaches this critical level.

Understanding IV (implied volatility) Crush is crucial for options traders because it is a key component of option pricing. 

In this article, we will explore the concept of IV Crush in options trading. We will begin by defining implied volatility and its importance in options trading. Then, we will discuss what IV Crush is, how it occurs, and the factors that can cause it.

What is IV (Implied Volatility)?

Implied volatility (IV) represents the market's expectation of the level of volatility that will be realized in the future for a particular stock or index. IV is crucial to understand as an options trader since it significantly affects option pricing.

When implied volatility is high, this signals people are expecting a large move in the stock. Therefore, options are more expensive since people are speculating on a significant move by purchasing options contracts.

On the other hand, when implied volatility is low, options are much cheaper since people don’t feel the need to actively hedge or speculate on a large move. 

Options with a higher IV are more expensive because they have a greater chance of ending up in the money, and vice versa. As a result, traders must be aware of the current IV levels to assess the fair value of an options contract and determine if it is overvalued or undervalued.

What is an IV Crush in Options Trading?

Implied volatility crush, or IV crush, occurs in the options market when the implied volatility of a stock rapidly decreases. This can happen for various reasons, such as changing market conditions or stock-specific news. 

IV crush often occurs after a major event, such as an earnings report or a news announcement that caused IV to be elevated.

The extrinsic value of an option is dependent on the IV, so when an IV crush occurs, the extrinsic value drops significantly. A drop in IV indicates that traders no longer expect a significant move causing option prices to decrease. 

Earnings announcements are one of the most significant events that can lead to an IV crush. Earnings reports tend to bring uncertainty, and investors tend to anticipate a larger than normal move in the stock's price.

How to Calculate the Implied Move

The implied move is how much an underlying stock is expected to move over a period of time. It is often used in options trading to help traders make informed decisions about which options contracts to buy or sell.

You can calculate a stock's implied move by determining the price of an ATM straddle. If you want to find the implied move of an earnings or news event, you should build the straddle on the expiration date right after the event. 

For example, if a stock is trading at $100, you would buy the $100 call and put to build a straddle. Say the total cost of the strangle is $10. This means the expected move of a stock for that expiration cycle is $10. 

If the underlying stock stays within the implied move, option sellers will win, and option buyers will lose. 

If you believe a stock will not move outside of its implied range, you would sell options. If you believe that IV is understated and the stock will move outside of its implied range, you should be a buyer of options. 

It's important to note that calculating the implied move is not an exact science, and it's not a guarantee of how the stock will move. However, it can provide a good estimate of the potential price movement, which can help traders decide whether they should buy or sell premium.

IV Crush Following Earnings

Earnings announcements can significantly impact the underlying stock's price and the expected volatility, leading to an IV Crush.

When a company releases its earnings report, the market will react, causing the stock to sell off or get bought up, depending on whether the earnings were better or worse than expected. This can cause the stock price to fluctuate significantly, affecting the implied volatility of options contracts on that stock.

Before an earnings announcement, traders generally buy more options than usual, causing IV to increase. When a stock releases earnings, several investors may change their minds about the stock depending on how the earnings look, which causes more uncertainty than usual. 

After the earnings announcement or news is released, implied volatility (IV) tends to drop quickly and significantly as the unknown becomes known, and the stock price reacts to the information. This drop is called IV crush.

How to Profit From the IV Crush

The most common way to profit from IV crush is to sell options before a company reports earnings. If a trader believes implied volatility is overstated, they can profit by utilizing short volatility strategies like the iron condor or short strangle. 

To implement this strategy, you would find a stock reporting earnings in the near future. Next, you would sell a strangle or an iron condor on the expiration date following the earnings announcement. 

Iron Condor

The iron condor involves selling an OTM call and put and buying even further OTM calls and puts to make it a defined risk trade. An iron condor benefits from IV crush if the stock stays within the implied move, allowing you to generate a quick profit. 

However, if the underlying stock moves further than its expected move, the iron condor will lose money, and you may take a loss. Having a plan for when trades become losers is crucial to managing your risk. 

Short Strangle

The short strangle is similar to the iron condor, as it involves selling OTM calls and puts. However, the short strangle doesn’t include buying any options, making it an undefined risk trade. 

The short strangle allows you to collect more premium but is significantly riskier as the risk is undefined. Therefore, if the underlying stock moves substantially further than its expected move, you can take a significant loss. While each strategy offers opportunities for traders to profit from IV Crush, they also come with risks that traders should be aware of.

While earnings season is over, it won't be long before it comes around again. During this break in the action, it's a good time to review some basics about how implied volatility (IV) impacts option prices. IV plays a key role in determining the price you pay to buy an option, so it's critical to keep entry costs at a minimum in order to take full advantage of the leverage provided by options. To pinpoint stocks with attractively priced options, we've developed two proprietary volatility-based indicators: Schaeffer's Volatility Index (SVI) and Schaeffer's Volatility Scorecard (SVS).

Finding Cheap Short-Term Options with SVI
The Schaeffer's Volatility Index (SVI) is the average at-the-money (ATM) implied volatility of a stock's front-month options. The indicator is helpful to determine whether short-term options are currently pricing in high or low volatility expectations, relative to the past year's worth of data.

SVI is calculated by averaging the IV of four different options -- two calls and two puts, both in the front-month series (until the week prior to expiration, when it rolls to the next available month). Two strike prices are used; the strikes immediately above and below the stock price. The resulting average IV reading is the SVI, which is then assigned an annual percentile rank (with 0% being the lowest, and 100% the highest).

The higher the SVI percentile, the higher short-term volatility expectations are at the moment. Thus, options traders should ideally target stocks with low SVI percentile rankings, because this means near-term options are pricing in relatively low volatility expectations. Given that volatility tends to spike as known events approach, equity SVIs are usually highest prior to earnings releases.

By avoiding options with inflated SVI readings, and honing in on those with low SVIs, premium buyers can keep their cost of entry low, minimize the negative impact of time decay, and maximize the leverage of options.

Using SVS to Find Stocks That Defy Expectations

Unlike the forward-looking SVI, the Schaeffer's Volatility Scorecard (SVS) is a lagging indicator that measures a stock's realized volatility against the volatility expectations priced into that stock's options over the past year. The goal is to find which stocks have been the best -- and worst -- for premium buyers.

SVS is calculated by creating a hypothetical at-the-money straddle trade with a constant 21 days until expiration each trading day of the year, generating about 250 data points annually, with IVs derived from actual at-the-money options. The hypothetical straddle is assumed to be held until expiration, when it's closed out for intrinsic value. Based on these trades, the SVS accounts for three criteria: 40% is based on the average straddle return; 40% is based on the percentage of positive returns; and 20% is based on the percentage rank of the straddle IVs. These metrics are then combined into a score ranging from zero to 100.

If a stock has a high SVS, the underlying equity has tended to realize greater volatility on the charts over the past 12 months than what its options have priced in. The SVS then, unlike SVI, accounts for not just IV relative to itself, but IV relative to historical volatility (HV). 

As we work to uncover winning call and put trades for subscribers, both the SVI and SVS are critical tools we use to determine prime option-buying opportunities. To learn more about identifying options trades with appealing risk-reward setups, check out these tips, and find out how to use leverage ratios.

A volatility crush is the term used to describe the result of implied volatility exploding once the market opens higher or lower than where it closed the previous day. For new investors, implied volatility almost always seems to rise after a stock moves in either direction. It is not that unusual for this spike in volatility to occur even when there is a small movement in the stock price. What happens next is known as a “volatility crush” as the option moves through its cycle and back towards the price of the stock.

There are many different aspects of a volatility crush to be aware of as an options trader. Among the most important terms is implied volatility, which occurs in anticipation of a major percentage move. Implied volatility will often decline just before the move happens, setting up long options bets for a profit.

This article discusses implied volatility and volatility crush, as well as several easy ways to benefit from both.

What is implied volatility, and how does it impact options pricing?

Pricing options is a complex science involving the strike price, length of expiry data, stock price, and the expected volatility in price over time. You will find more expensive options when you compare strike price to the current price (or ask to buy) and find a larger difference. Combined with the rapid increase and decrease of the demand in the market, you are creating implied volatility that options traders expect.

Implied volatility is essential to understanding the pricing of any stock or option. Understanding the curve of demand, especially leading up to earnings or big announcements, can be the difference between profiting during a volatility crush and losing your bank.

What is a volatility crush?

A fast, sharp drop in implied volatility will create a volatility crush in the value of an option. This often happens after a major event for the stock, like financial reports, regulatory decisions, new product launches, or quarterly earnings announcements.

Many traders have their eye on the volatility crush – an options trading strategy that uses both puts and calls to profit from an expected dip in implied volatility. It is often based on the idea of an earnings announcement, and more specifically, a stock’s implied volatility in the middle weeks before earnings.

For instance, in these instances, the market makers price into options (via implied volatility) substantial price action ahead of the event. This is why it is essential to understand implied volatility levels prior to initiating a trade. 

If volatility is higher entering a major event, it will be more expensive to buy stock options. After the event, the price of the stock didn’t rise as much as the analysts expected, or the stock price actually went down. While, even when the price of the stock goes up, the uncertainty of price point resistance and other factors decreases the premium on the option. Therefore, the option price drops, and even though the stock may be rising, the option is not.

The disconnect between the stock movement and implied volatility crushes the options market and leaves you, the trader, with a losing trade even though the stock could be increasing.

Another instance is during a significant downside movement on the Market Volatility Index (VIX), typically a macro-level development in the market overall. A significant plunge in VIX is a trigger for traders that implied volatility is higher than historical volatility, and the resulting volatility crush is going to take your profits or turn modest winners into losers, not to mention a horrible entry.

What is an example of volatility related to earnings?

Here are two examples of how to understand volatility in the market:

1. You have AAPL at a share price of $100 the day before earnings, with a straddle price at $2 one day before expiration (market expectation of 2% move on earnings day or $2.00/$100 = 2%).
2. You have TSLA share price of $100 the day before earnings, with a straddle price of $15 one day before expiration (market expectation of 15% move on earnings or $15/$100 = 20%).

It doesn’t take an experienced veteran to see the difference between the market expectations for earning in these two examples. What does this mean to an options trader? Trading on the 15% scenario and selling the straddle pre-earnings, the position would be a winner if the stock never moved less than 15% on earnings day.

Conversely, trading on the 2% example, an options trader with knowledge of historical AAPL earnings reports to understand the significance of a 2% move may elect to stick with the position as a “fairly” valued opportunity. 

Regardless of the strategy or scenario, understanding the historical perspective on volatility is essential to understanding options trading. This is where you find the wins, and the true opportunity of earnings comes to life. With the exception of horrible news like failed technology or company liquidation, earnings are a great opportunity to create a winning trade. Also, in these scenarios where the stock is crashing, options will go into a volatility crush. This may seem obvious and related to fear, but you can imagine this scenario easily. SPY is crashing down, and VIX is going up.

Summarizing Volatility Crush and Implied Volatility Terminology

A volatility crush is an opportunity for traders to take advantage of a pattern of predictable price movement across the options market. When you understand premium rates increasing during a substantial event (like earnings) followed by the decrease in implied volatility, you can make smarter trades, informed positions, and better moves for your overall account.

For any trader, implied volatility (IV) is one of the most important considerations because it has a direct impact on pricing. It’s even more important now as IV spreads have grown significantly wider, and the concept of a “volatility crush” has become an increasingly viable options trading strategy. It has been my experience that implied volatility increases before an earnings announcement and that this increase is due to option writers who want to ensure adequate protection of their portfolios from significant price fluctuations in the market.

Tech stocks have taken a tumble lately, led by a steep slide in Apple (AAPL) shares. Since touching a record high of $146.59 on Friday, Sept. 15, the PowerShares QQQ Trust (QQQ) has pulled back close to 2.7%. Likewise, the Technology Select Sector SPDR Fund (XLK) touched an all-time peak of $59.17 on Tuesday, Sept. 19, but has subsequently slid 2.3%.

Today, both tech-based exchanged-traded funds (ETFs) are pacing for their worst session since Aug. 17, with Facebook (FB), Apple, and fellow FAANG stocks Amazon (AMZN), Netflix (NFLX), and Alphabet (GOOGL) all in the red. Below, we'll talk about the crazy demand for out-of-the-money (OOTM) put options on QQQ and XLK, even as the funds approach what has historically been their best month of the year. 

Demand Soars for QQQ Put Options

As with the S&P 500 Index (SPX), OOTM put options on QQQ are more expensive than usual. The 18.9% implied volatility (IV) to insure against a 5% QQQ slide in the next month (via the October 135 put) is way higher than the 11% IV of the October 150 call, which is 5% above the current QQQ price. What's more, the IV of the OOTM put is roughly double the fund's 30-day historical volatility (HV) of 9.6%. Against this backdrop, the 10-day moving average of the tech fund's OOTM put/call skew is now approaching 2.0 -- exceeding the pre-election peak from September, and marking the highest since at least 2009 (as long as we have data).

Per Trade-Alert, QQQ currently has 3.29 million OOTM puts in open interest -- more than double the 1.41 OOTM calls outstanding. While the in-the-money October 144 put is the most populated among front-month strikes, home to nearly 134,000 contracts, the OOTM October 139 put carries a similarly noteworthy 101,000 contracts. QQQ shares are currently down 1.2% to trade at $142.65.

XLK Put/Call Skew Cools from 3-Year High

It's the same story with the XLK, which is down 1.3% at $57.78. The 10.9% IV of the October 61 call (representing a 5% rally in the ETF) pales in comparison to the 18.2% IV of the out-of-the-money October 55 put (representing a 5% drop). Further, the put's IV is more than twice XLK's 30-day HV of 8.5%. The XLK's 10-day moving average of its OOTM put/call skew recently peaked above 1.9 -- the highest point since mid-2014.

XLK's OOTM put open interest stands at 253,000 contracts -- about five times the 54,000 OOTM calls in residence, and representing more than 90% of the fund's total put open interest. In the front-month October series, peak open interest can be found at the now at-the-money October 57 put, home to nearly 4,400 contracts. In the November and December series of options, though, peak open interest stands at the 55-strike puts.

The Best Time of the Year to Buy Tech Stock ETFs

Despite the recent tech headwinds, the sector has been outstanding in 2017. QQQ is now testing its footing atop its 80-day moving average -- a trendline that coincides with a round 20% year-to-date gain, and contained the fund's late June/early July swoon. Meanwhile, the XLK is also up roughly 20% year-to-date, and could find support atop its ascending 10- and 20-week moving averages. 

It's also worth noting that October is historically the best month to own both the PowerShares QQQ Trust and the XLK. Since inception, QQQ has averaged an October gain of 4%, according to data from Schaeffer's Quantitative Analyst Chris Prybal -- more than double its second-best average monthly gain of 1.7%, which occurs in November. The XLK also tends to shine in October, gaining an average of 3.4% since inception, and rallying another 1.8% in November. Should the funds resume their quest for record highs, now could be an opportune time to buy those relatively inexpensive OOTM call options.

Even with the U.S. stock market carving out record highs in today's trading, the CBOE Volatility Index (VIX) is up 1.8% at 9.68, on track for its second straight day of gains. While this upside should be taken with a grain of salt considering the market's "fear gauge" is lingering in single-digit territory -- and near historically low levels -- call volume on the volatility is running at a slightly accelerated clip today.

At last check, more than 457,000 calls had traded on VIX -- about 1.1 times what's typically seen at this point in the session -- compared to around 77,000 puts. Most of the action has centered at the December 16 call, where Trade-Alert highlights a 79,000-contract block that was possibly bought to open for an initial cash outlay of about $10.42 million (number of contracts * $1.32 net debit * 100 shares per contract).

While this options trade could represent a speculator who is growing more bullish in their volatility bets, VIX hasn't printed north of 20 since Nov. 9 -- the day after the U.S. presidential election. As such, it's likely this big options bet is a result of a traders hedging against an end-of-year volatility spike.

Supporting this theory is the latest Commitments of Traders (CoT) report, which showed a massive net short position on VIX futures. In fact, large speculators increased their net short position on VIX futures for a fifth straight week -- to the largest short position ever, going by the number of contracts.

Trading options can be complicated, as there are a lot of moving pieces. It's important to stick to a core set of principles when approaching any options trade. Here at Schaeffer's, we have a simple mantra for vetting stocks before buying an option: F.A.R., or Fast, Aggressive, and in the Right direction. That is how you need a stock to move in order to profit on a short-term call or put purchase. Below, we will unpack this mantra, and outline what metrics are used to judge it.

A Stock Must Move Fast Due to an Option Trade's Finite Life

The reasons why you want a stock to move fast is because of two factors. First, the expiration date of an option shortens your timeline to profit. In other words, you have a narrower window of opportunity compared to a stock buyer. If you think a stock will slowly move up or down the charts, a short-term options play may not allow you to fully capitalize on the momentum (or lack thereof).

Second, because time is the enemy of the option buyer, the value of his/her option position will deteriorate with each passing day by an increasing amount, absent a significant price move in the preferred direction. To combat time decay, the option buyer wants the underlying security to move Fast.

A Stock Must Move Aggressively for the Option Buyer to Profit

The reason why you want the underlying stock to move aggressively is due to the setup of an option trade. In order to exceed the breakeven price on an option purchase, you need the stock's move to be of such magnitude that it at least covers your initial premium paid. Indicators such as the Schaeffer's Volatility Scorecard (SVS) make it easier to compare stocks that tend to make outsized moves on the charts, relative to what the options market has priced in.

A Stock Must Move in the Right Direction -- But Not Always

The reason why you want a stock to move in the Right direction is fairly obvious. If you expect the stock to go up and it goes down, you lose money on your call purchase. However, one great thing about options trading is the ability to profit in really any situation. For example, the long straddle and long strangle essentially eliminates direction from the equation. A trader can then focus on customizing the timing and magnitude of their options trade.

Even If the Stock Doesn't Move F.A.R., Risk Is Limited

In conclusion, the finite life of an option contract means that options traders must time the underlying stock's expected move precisely, and hope the shares move Fast enough before options expiration. Even more, they need the equity to move Aggressively enough to make money on their options trade, and obviously in the Right direction. But, even if the option buyer is wrong, the most he or she can lose on the trade is the initial premium paid for the contract, so unlike a stock buyer, risk is limited. For a deeper dive on this subject, check out tips for short-term options trading, or how to trade weekly options.

This Thursday, Oct. 19, will mark the 30th anniversary of Black Monday -- when the stock market notoriously crashed in 1987. This week, we'll be publishing a handful of features in observance of the event, kicking off today with stats on stock market performance before Black Monday, the hypothetical CBOE Volatility Index (VIX) reaction, and how the S&P 500 Index (SPX) has performed after its last dozen meltdowns.

SPX in 1987

Stocks were doing very well before the Oct. 19, 1987 stock market crash. At its 1987 high on Aug. 25, the index reached 337.89 and was up nearly 40% year-to-date, according to Schaeffer's Senior Quantitative Analyst Rocky White.

What's more -- and what many people may not realize -- is that even despite Black Monday, the S&P managed to log a 2% gain on the year, marking its sixth positive annual return. The index gained another 12.4% in 1988, and 27.3% in 1989.

Panic in the Options Pits

While the VIX -- or the stock market's "fear gauge" -- wasn't officially launched until 1993, reverse engineering by the Chicago Board Options Exchange (CBOE) shows us just how panicked the stock market was on Black Monday. The CBOE S&P 100 Volatility Index (VXO), which basically uses the pre-2003 VIX volatility calculations and has price history going back to 1986, rose 313% to an all-time closing high of 150.19.

The following day, "Everyone wanted to own put options and the bid/ask markets reflected the panic," Mark Wolfinger recalled. "[T]he chasm was indescribable," and option premium that Tuesday was through the roof. "Implied volatility reached values so high that they have never been seen again."

Circuit Breakers and Rule 48

In the wake of Black Monday, circuit breakers were introduced to halt trading if the stock markets make a huge move lower in a matter of hours. Until the October 1997 "mini crash," circuit breakers were triggered by Dow Jones Industrial Average (DJIA) point drops, as opposed to SPX percentage drops. Now, there are three circuit breaker tiers that could temporarily halt trading, assuming they happen before 3:25 p.m.: a 7% drop halts trading for 15 minutes; a 13% drop halts trading for 15 minutes; and a 20% drop halts trading for the remainder of the day.

Evolving from that, Rule 48 came into play in late 2007, and was first invoked on Jan. 22, 2008, around the start of the financial crisis. In a nutshell, the Securities and Exchange Commission's (SEC) Rule 48 is designed to calm the markets before the opening bell, when stocks are signaling a huge drop out of the gate. Rule 48 was invoked several times in August and September 2015, and premarket circuit breakers were triggered after the 2016 presidential election shocker.

SPX After Meltdowns

Below are the instances when the S&P 500 Index (SPX) dropped 7% or more in a single day, going back to Black Monday. The last time this occurred was on May 6, 2010, during the market's "flash crash." Five of the massive SPX drops happened in the throes of the financial crisis in 2008, prior to which you'd have to go back to April 2000 for a 7% intraday drop. There were no SPX declines of this magnitude in the 1990s.

It's also interesting to note that seven of the 12 crashes below happened in the month of October (but we'll have more on that tomorrow). Of course, five of those were October 2008, which skews the S&P's three- and six-month returns after big drops, considering the market bottom wasn't in place until March 2009.

Nevertheless, the stock market index tends to outperform after massive down days, likely as traders go bargain hunting. The SPX averages one-day and one-week returns of 2.94% and 4.46%, respectively, after these drops, with a win rate of 75%. That's much higher than the index's average one-day and one-week anytime returns since 1987, per data from White. In fact, with the exception of the three- and six-month time periods, due to the aforementioned 2008 data, the SPX performs much better than usual across the board one year after a big drop.

As alluded to earlier, make sure you tune back in tomorrow for the second part in our Black Monday Anniversary series, where we'll discuss the worst days of the year to own stocks, historically, and take a look at notable stocks that survived that notorious day.

One must go back to Oct. 4, 1968, to experience a market environment where the 30-day historical volatility (HV) of the stock market was lower than it is now, according to Schaeffer's Quantitative Analyst Chris Prybal. Could this be the calm before the storm for the S&P 500 Index (SPX)? Here's what to expect from the SPX going forward, if past is prologue.

SPX Historical Volatility Falls Below 5

Although the 1960s were a rather tumultuous time socially and politically, there were a few stretches of quiet gains in the stock market, going by the number of times the SPX's 30-day HV fell below 5: in history, 20 times, and 18 of them in the 1960s.

On Monday, the 30-day HV of the SPX fell all the way to 4.377 -- the first reading below 5.0 in 49 years. For context, the S&P closed that day in 1968 at 103.71, and it was the lone signal of 1968. There was also just one signal in 1957 -- the first ever -- as well as in 1962, 1966, and 1967, according to Prybal. Most of the signals happened between 1963 and 1965, as the S&P was grinding higher.

The Calm Before the Storm?

"While many see low HVs or implied volatility readings as the 'calm before the storm,' in only three of 19 instances was that the case," notes Schaeffer's Senior V.P. of Research Todd Salamone. Those "storms," wherein the SPX was notably lower six months out, followed the first and second signals, in 1957 and 1962, and the signal in 1966 -- just 16% of instances.

"The other thing that hit me is that in five of 16 cases, the SPX rose by more than 4% in the three months following a 30-day HV reading below 5," Salamone added. In fact, the SPX was positive at the three-month marker 68% of the time. Only at the one-month point after 30-day HVs breach 5 did the SPX have a win rate under 50%.

Still, compared to its anytime performance since 1928, the stock market barometer tends to run a bit lackluster after these HV signals. For instance, four months after a breach of 5 for SPX 30-day HVs, the index was flat, on average, compared to a 2.5% anytime four-month average gain. And the S&P was up 1%, on average, six months after a signal, compared to an average anytime six-month return of 3.7%.

As Salamone concludes, "It's probably one of those signals where, based on history, the probability of a 10% pullback is more than normal -- but it's still pretty low." For traders concerned about a possible correction in the stock market, there are several ways to use options to hedge your portfolio.

Today marks the 30th anniversary of the infamous 1987 "Black Monday" stock market crash, and -- despite a geopolitical environment that's fairly riddled with risk and uncertainty -- the major equity indexes have soared to multiple consecutive record highs. Meanwhile, over the last six months, the average daily CBOE Volatility Index (VIX) reading has been a mere 10.82 -- well below the VIX's five-year mean of 14.66. So, given that we're smack in the middle of the worst month for market crashes, is this price action pointing to another imminent bout of mayhem for U.S. stocks?

For an expert's take on the odds of another crash -- plus, pro tips on how to protect your portfolio in the worst-case scenario -- we turned to Schaeffer's Senior Trading Analyst Bryan Sapp. As one of the strategists behind our straddle-driven Volatility Trader series of options trading recommendation services, Sapp knows a thing or two about sudden, volatile stock moves.

Elizabeth Harrow: The official Fed essay on the 1987 stock market crash discusses both "portfolio insurance" derivatives and "triple witching" expiration as contributing factors in the Black Monday sell-off. To what extent do you think the 1987 crash still colors the average investor's perspective on options trading, if at all?

Bryan Sapp: In my opinion, the 1987 crash is the furthest thing from anyone’s mind right now. I’ve seen a few articles on it this week just because it’s the 30th anniversary, but I’m guessing it’s writers looking for content since the market is so riveting lately. [Editor's note: Accurate.]

How could the average investor in 2017 make good use of options to gain protection against a market crash?

Buying put options -- and especially index put options -- has been a great way to lose money for a few years now, but that’s probably the best way to protect against a crash, here and now.  It all comes down to the timing of it, should the market roll over hard -- but given how cheap index options are (and for good reason), a trader who could time a big move lower would be set up to make a mint, given the current options pricing.

Do you recommend buying put options on broad, equity-based ETFs (like SPY, QQQ, IWM, etc.) for those looking to pick up crash protection? Why or why not?

Index puts have been a preferred way for hedge funds to protect against downside for some time now.  It’s been a "waste" of money for a while -- but generally, it makes sense as a hedge in the event that someone is looking for protection against a multi-sigma move, because the implied volatility of the index options will be much less than that of most individual equity names.

When stock prices are crashing and VIX is spiking, how can traders determine whether buying put options at inflated implied volatility levels is "worth it," in terms of the premium paid vs. downside protection gained?

In order to determine if an option is "worth it," a trader must make some sort of prediction about future volatility of whatever instrument they’re looking to trade. In the event that current implied volatility is less than perceived future actual volatility, then the option is "cheap" on a relative basis.

Are there any trading strategies that you view as particularly risky in the current market environment (or regardless of environment)?

To me, the trade that looks the most dangerous here and now is shorting volatility. Yes, it’s worked for a very long time now, and appears to be free money, but it’s a super-crowded short at this point. In fact, per the Commitments of Traders (CoT) reports over the past two weeks, total short open interest on VIX futures is currently at an all-time high. 

Sure, it’s most likely that the VIX will continue to move lower, given what’s been going on lately.  However, in the event that we get some sort of shock -- whether it be geopolitical, market-related, etc. -- risk/reward is very skewed here. Should the VIX see some sort of spike, it will most likely move disproportionately to the upside, making it tough (at least in my mind) to stay short volatility for a prolonged period here.

As a trader, how have you reacted to some of the drastic short-term crashes in recent years (like May 2010 and Sept. 2015, for example)?

In the event of big crash-type moves like you mentioned, if you’re not prepared or positioned for them ahead of time, it’s generally too late to react, unless you’re very nimble and can position short term. The best way to react is to de-risk and wait for a good spot to re-enter the market. 

These types of moves happen so quickly now, with all of the algorithmic trading that takes place, that trading on a very short time frame can be difficult from a trade execution perspective. For those who do trade during these types of events, defining and respecting risk is key. When markets get that volatile over short periods, big risk can happen in a hurry.

What types of indicators would signal to you that the market is at risk of a sudden, "crash"-type decline from a technical perspective and from a sentiment perspective?

From a technical perspective, I look for parabolic price action. When stocks, indexes, etc. accelerate to the upside, it increases the potential for an outsized counter-trend move. From a sentiment perspective, I like to watch for extremes in put/call ratios, anecdotal sentiment (via Twitter, media coverage, etc.), and various sentiment polls that we follow at Schaeffer's (including Investors Intelligence, the American Association of Individual Investors, and CNN Fear & Greed).

As just another example of the low stock market volatility of late, the CBOE Market Volatility Index (VIX) -- or Wall Street's "fear gauge" -- is flashing a signal so rare we've seen it just four other times since 1990. Specifically, VIX premium has crested above 200%, according to Schaeffer's Quantitative Analyst Chris Prybal, which was a really bad signal for the VIX in 2016. Below, we'll explain what VIX premium is, and what it could mean for the S&P 500 Index (SPX) going forward.

The lofty VIX premium indicates short-term S&P options are "overpricing" volatility expectations relative to the volatility the index has actually realized over the last four weeks' worth of trading. In other words, it's a measure of how expensive the VIX is based on the SPX's previous 20 days' worth of trading. Mathematically, the VIX premium is simply [VIX - 20-day SPX historical volatility (HV)]/20-day HVs, expressed as a percentage. We considered only one signal every 21 trading days.

The last time it crested 200% was on Aug. 9, and prior to that just before the November election surprise. Before that, the VIX premium topped 200% on June 22, 2016, at the start of the Brexit panic. The only other time this signal has flashed since 1990 was in late December 2010. As you can see on the chart below, previous signals have preceded notable VIX drops.

Six months after the last drop, the VIX was down 55.75%, per Prybal. After the June 2016 signal, the fear gauge was nearly 46% lower at the six-month point. And half a year after the late 2010 signal -- in which the VIX premium touched a record 289% -- the VIX was 10.59% lower.

On average, the VIX was down 37.42% six months after the signals. That's compared to an average anytime six-month gain of 4.36%, going back to 1990. In the shorter term, the VIX was in the red on average at every checkpoint starting at the one-week marker, and was negative 100% of the time three, four, and six months after a signal. That's compared to average anytime gains across the board.

Considering the "fear barometer" tends to drop when stocks are doing well, it's no surprise to find that the S&P 500 Index tends to outperform after these signals. Both two weeks and one month after a signal, the SPX was higher 75% of the time, with much bigger-than-usual gains. The index was higher 100% of the time two, three, four, and six months after a signal.

In fact, the index's post-signal average one-month gain of 3.33% is nearly five times its average anytime return of 0.69% since 1990. Likewise, the SPX averaged a three-month post-signal gain of 6.48%, about three times its average anytime return of 2.06%. Six months out, the SPX was 10.1% higher, on average, compared to an average anytime gain of 4.22%.

Of course, with just five signals total, the sample size is too small to jump to any significant conclusions just yet. Still, if recent history repeats, the VIX could be on track for record lows in single-digit territory, and the Chicago Board Options Exchange (CBOE) recently added an 8.50-strike VIX option for the first time in history.

Likewise, the S&P could be headed to even higher record highs over the next few months -- particularly considering "headline risks have been sufficient to prevent the kind of euphoric atmosphere that is prevalent at key market tops," according to Schaeffer's Senior V.P. of Research Todd Salamone.