Lessons from Past Panics: How Crises Created Option Selling Opportunities

Lessons from Past Panics: How Crises Created Option Selling Opportunities

Major volatility spikes over the past two decades. The 2008 financial crisis (center) and the 2020 COVID crash (right) saw the VIX fear index surge to record levels (~80+), reflecting extreme panic. These periods of market chaos corresponded to historically overpriced option premiums, which proved to be lucrative opportunities for disciplined option sellers once the turmoil subsided.

History provides vivid examples of how fear and volatility go hand-in-hand, and why those volatility blow-ups can reward contrarian traders. Let’s briefly revisit three major market crises – the early 2000s dot-com bust, the 2008 financial crisis, and the 2020 pandemic crash – to see what happened with volatility and option pricing in each case, and how some traders capitalized on the chaos.

• Dot-Com Crash (2000–2002): The unwinding of the tech bubble and the shock of the 9/11 attacks led to a grinding bear market. Volatility spiked significantly during this period – the VIX peaked around the mid-40s​. Many investors were shell-shocked as the Nasdaq collapsed, and protective options were in high demand. An option seller in this environment could collect much higher premiums than usual, though the fear persisted for an extended period (unlike a quick crash, this was a prolonged slump). One lesson here was the importance of patience and duration: selling options further out in time or rolling positions could yield steady gains as volatility gradually mean-reverted from those ~40+ levels back toward the low 20s by 2003. Traders who sold wide iron condors or far OTM covered calls on solid blue-chip stocks during the panic often found that the feared worst-case scenarios never fully materialized, leaving them with premium in hand once the storm passed.

• Global Financial Crisis (2008): This was a fast and ferocious meltdown. In late 2008, as Lehman Brothers collapsed and the banking system faltered, the VIX exploded to ~80 – at that time, an all-time high​. Panic was at a fever pitch. Investors were desperately buying puts and selling stock to hedge their portfolios, driving option prices through the roof. For perspective, an at-the-money S&P 500 put option in October 2008 might have cost five or ten times what it would have cost in a normal market. Implied vol was extremely high, yet ultimately the market’s actual path, while volatile, was not as unbounded as the options implied. A few legendary investors recognized this mispricing. Warren Buffett, for example, famously sold long-dated index put options during this period to take advantage of the rich premiums. Berkshire Hathaway collected roughly $4.9 billion in upfront premiums on these contracts​ – essentially betting that by their expiration, the indexes would recover above the strike levels set during the panic. Buffett later noted he believed those contracts were dramatically mispriced in his favor at inception​. While those trades carried substantial theoretical risk, they underscore the core idea: when fear is extreme, option prices can far exceed reasonable expectations, and selling into that fear can be incredibly rewarding if done prudently. More ordinary options traders in 2008 who sold options with nearer expirations also did well provided they managed risk: for instance, selling 3-month-out bull put spreads on quality stocks after the initial crash, or selling index options with strikes deep below the market (essentially betting that the world wasn’t literally ending). By early 2009, volatility started calming and those who had sold at peak fear were able to buy back contracts at a fraction of what they sold them for (or just let them expire worthless), pocketing the difference.

• COVID-19 Crash (March 2020): The pandemic panic set new records for velocity. Within weeks, the S&P 500 plunged ~34%, and the VIX spiked from a complacent ~14 in February to an astounding 85 at its peak in March 2020​– even higher than 2008’s peak. This was a classic volatility shock: the sudden uncertainty about a global pandemic made traders extremely fearful of further crashes, and option premiums exploded accordingly. Implied volatility on many stocks went to extreme percentiles; even deep out-of-the-money options that usually trade for pennies suddenly traded for dollars. Yet, by late March and April 2020, massive stimulus and a realization that the world was not going to end saw markets stabilizing and bouncing sharply. Volatility collapsed almost as quickly as it had spiked. For option sellers, this was a textbook case of a volatility boom-and-bust: those who could keep their wits about them during the darkest days of March had the chance to sell options at phenomenal prices. For example, some traders sold far OTM put spreads on broad indexes or strong companies in late March, essentially saying “I’ll bet that things won’t get much worse than this.” Because IV was so high, they could sell puts 20-30% below the current market level for huge credits. When the market indeed bottomed and rebounded, these contracts lost value rapidly, yielding profits for the sellers. One could also sell wide iron condors on the index after the initial plunge – the range of potential movement was huge in price terms, but with VIX at 80+ the premiums were rich enough that even strikes far apart provided substantial income. The key lesson from 2020 was how quickly one must act (and how carefully one must manage trades) – the entire drama from peak fear to recovery happened in a matter of months. It reinforced that staying objective when everyone else is panicking is crucial; the window to sell at extreme premiums can close fast as the market regains composure.

Across these episodes, a common pattern emerges: when fear was rampant, options were grossly overpriced relative to eventual reality. Each crisis had investors imagining doomsday scenarios – and pricing options as if those might happen immediately – but eventually the markets found a bottom and volatility subsided. The traders who sold insurance during the panic (instead of buying it) often reaped large rewards. Of course, timing and risk management were everything. Selling too early or without a plan could be disastrous (for instance, an option seller in early 2008 who didn’t anticipate just how bad things could get might have been steamrolled until the market turned). But selling after volatility had already spiked to historic extremes, in a diversified, well-managed way, proved to be a winning approach in each case.

Lessons from past volatility spikes:

• Fear Overshoots Reality: In major panics, people often expect far worse outcomes than actually occur. Option prices reflected catastrophic expectations (indexes going to zero, etc.), which rarely came true. The implied vol was higher than subsequent realized vol in each case, yielding a built-in edge for sellers​.

• Contrarians Are Rewarded: It’s psychologically hard to sell into a falling market, but history rewards those who can. The best opportunities appeared when sentiment was terrible. For example, Buffett’s contrarian premium-selling in 2008, or traders selling puts in March 2020, were going against the crowd – and that’s exactly why the crowd paid them so well to take the other side of the fear trade.

• Risk Management Is Critical: In all cases, the market was extremely volatile during the spike. If you sold options, you had to withstand big swings. The successful sellers used methods to survive those swings – whether by selling farther-dated options (Buffett’s puts had lots of time to recover), using spreads to cap risk, scaling position sizes down, or having hedges. They also often sold on the way down (after volatility had jumped) rather than too early in the decline.

• Volatility Spikes Don’t Last: Though each crisis felt endless in the moment, they all eventually passed. Volatility is inherently cyclical. Huge spikes tend to be followed by normalization. Knowing this can give you confidence to take the other side when everyone else is terrified. As the saying goes, “This too shall pass.” For an option seller, your worst enemy is a sustained increase in volatility that doesn’t revert. History suggests that even in dire scenarios, volatility eventually peaked and reversed, usually sooner than people expected in the moment.

By studying these episodes, we see why volatility spikes are a gift for premium sellers – but only for those who stay disciplined. Next time, I’ll discuss how to arm ourselves with some tools to recognize and quantify when volatility is truly “high,” and how to systematically approach selling into those conditions.

Stay tuned!

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Probabilities over predictions,

Andy Crowder