Jump risk refers to the potential for sudden, large price movements that “jump” beyond normal volatility patterns, often triggered by unexpected news, geopolitical events, or market disruptions. These discontinuous price changes can cause significant losses for traders using strategies that assume gradual price movements or rely on normal volatility patterns.

Jump risk is particularly challenging for options pricing models and dynamic hedging strategies that assume continuous price movements. Traditional volatility measures may underestimate the potential for extreme price jumps, requiring additional risk management tools and stress testing. Understanding jump risk helps traders select appropriate position sizes and hedging strategies.

Real-world example: A surprise OPEC production cut announcement causes crude oil prices to jump 8% in minutes, creating losses for traders short oil futures and challenging options pricing models that didn’t anticipate such rapid price movement.