Furthermore, the original purpose of. In this sense, LPs lose profit due to their inherent GEX and inability to actively hedge it. argue that the quantity W below represents the total arbitrageur profit. For more on TradFi MM GEX, see, , the authors Milionis et al. As prices rise, the market maker must add positive exposure thereby adding "fuel to the fire" by buying more. Suppose we assume the same price process as Milionis et al. However . Thank you for your interest. For any single option, gamma is a bell-shaped curve centered around the strike. Red Line: will give you where the Gamma Flip is. Many Git commands accept both tag and branch names, so creating this branch may cause unexpected behavior. Q&A -- So, the GEX interpreation in this condition is as follows: MMs will buy (sell) GEX dollar amount of SPX per 1% price decrease (increase). Strategies -- In a future post, Colin will discuss TradFi and DeFi MMs in more depth, as well as CFMM GEX and volatility from it. Set the variable "filename" equal to the file path to that download on your local drive. TLDR: This post compares DeFi LPs and TradFi MMs and connects the dots between LVR and GEX. The following image shows the GEX of the SP500 during the 25 of March 2022 (I don't remember the time when I ran this analysis but was during that day -, So, 9.81 Billion dollars the MM needs to buy or sell per 1% price move in the SP500 (taking as a reference the SPX). The preceding logic tells us that is the rate of change in ! When someone wants to buy or sell an option, a Market Maker (MM) will must likely be at the other side of that transaction; meaning that: If you want to buy an option, a MM will sell that option to you. Finding out net gamma positioning isnt a trivial task as it involves figuring out the direction of options trades. SPX (GEX) Dark Liquidity Gamma Exposure (Market Makers) Wish you all the best. Option markets use the (real-and made-up) Greek letters gamma, delta, vega, theta, and rho to quantify each option's economic exposure. So if we download (via Yahoo Finance or CBOE) the SPX, SPY and XSP option chain and apply the above formula to each strike and then add it all up, we can calculate the GEX for the SP500 (or at least it will be a good estimate according to our assumptions). Thus, by managing an LPs GEX, the LP can take back profit from arbitrageurs and keep it for themselves. Note that W is defined for any price process. Under no circumstances does any information posted on this website represent a recommendation to buy or sell a security. Correction - the assumption is that *customers* (not MM/dealers) buy calls and write puts (bullish plays), which make the MM short calls and long puts, both of which require long stock to hedge. **New Traders**: See the Options Questions Safe Haven weekly thread, Calculating the amount of time between two dates in Power-BI, Calculating the titanium equivalent strength of a steel rod, Calculating MVAR for summer and Winter of a 100MW solar farm. However, short put holders (the market makers) are forced to sell shares to become delta neutral again. . Gamma Exposure for Liquidity Providers Leads to Loss-Versus-Rebalancing, This site requires JavaScript to run correctly. If the gamma imbalance shifts towards call, then dips will be bought and volatility will be reduced as market makers delta-hedge their position by buying low and selling high. All started when I read a paper wrote by Squeeze Metrics called The Implied Order Book. If GEX is negative, MMs will sell all dips and will buy all rallies removing liquidity from the system and adding volatility (as a destabilizing force). Mainly, at any moment with. Volatility. The key question is: do the MMs need to BUY or need to SELL?? So, in general we will need to use the following formulas for us to be able to calculate the Gamma Exposure at any strike from a MM point of view: GEX (for call options) = +1 * Gamma * Open Interest * Multiplier * Spot Price, GEX (for put options) = -1 * Gamma * Open Interest * Multiplier * Spot Price. Gamma Exposure and its impact on financial markets, All started when I read a paper wrote by Squeeze Metrics called, Now, MM trading 101 in terms of risk management. Hence the market maker will attempt to be gamma neutral as well as delta neutral. The nonlinear payoff allows traders to make directional bets and hedge unfavorable price movements. Succinctly, if V(S) is the value of some position for price S, then =V and =V=. Milionis et al. Notice the term in the integrand g(S). Ok now trading 101 in terms of opening a trade. Notes on Gamma Exposure (GEX) - "GEX($ per 1% move)" is given as "Naive GEX", meaning that it is calculated under assumptions that Market Makers are buying calls and selling puts. However, at times of low liquidity, gamma flows can be responsible for significant price action around options expirations. The Gamma Exposure of this position, at that strike, is 1 share times 461 or 461$ (assuming the total OI at that strike is only 1). Its a source of one of the most significant structural flows in the equity markets. "Total Market Gamma" is often the metric that most people are familiar with. Market maker . A low gamma value translates to low volatility of an option position 's directional risk exposure. In no event shall me be liable to any member, guest or third party for any damages of any kind arising out of the use of any code, content or other material published or available on this website, or relating to the use of, or inability to use, this website or any content, including, without limitation, any investment losses, lost profits, lost opportunity, special, incidental, indirect, consequential or punitive damages. LVR was hinted at in an earlier paper Replicating Monotonic Payoffs Without Oracles (preprint). Press question mark to learn the rest of the keyboard shortcuts. To limit their market exposure, most dealers delta-hedge by selling shares of the underlying asset. So, if a market maker offsets this upside risk with Gamma Hedge by adding call options, or the underlying shares to the portfolio. In TradFi, MMs commonly play the role of a counterparty for options sales. Follow us on Twitter at @primitiveRnD for more content and see our GitHub for open source code and docs. The preceding logic tells us that is the rate of change in ! So that's why we have those positive and negative signs in our formulas simple, right??? The following image shows the GEX of the SP500 during the 25 of March 2022 (I don't remember the time when I ran this analysis but was during that day - important: this number changes every second!!!). How To Calculate Gamma Exposure and Zero Gamma Level. The direction is determined by the interaction between the aggregated gamma exposure of option market makers and the return until 30 minutes before market close. Gamma shows the potential amount of delta-hedging activity by the market makers. At the moment, this is around 4,660 for $SPX. Investors who use gamma-based. Interestingly, their results are more pronounced for stocks with high market capitalization. realize prot, an option market-maker must limit his exposure to deltas. https://spotgamma.com/why-market-gamma-levels-matter/ "Dealer gamma is a dollar value that estimates how much options dealers may have to hedge for a given move in the market..For example lets say the current gamma estimate is +$1,000,000,000 ($1bn). I wrote the article above on my blog and followed up with another one around how Gamma exposure plays out in the market and practical strategy ideas - e.g. This level tells you the strike price that separates the negative GEX area from the positive GEX area (others call this level as volatility trigger but it is exacly the same is when things turn negative or when things turn positive and a point where we can "expect" an increase or a decrease in volatility). The issue though is that squeeze metrics calculates GEX from the open interest, assuming that market makers buy calls and write puts.. which is probably ok for the names like AAPL or AMZN but a no-go for the names like GME or AMC. Options Fundamentals -- Current Plays and Ideas -- At this moment, the MM needs to short 30 shares of the underlying asset (SPY) to be fully hedged. I suck at options, but still want to use them. We discuss how market designers, crypto traders, LPs and quants can build positions to reduce the GEX loss vector. However SPX-Gamma-Exposure build file is not available. Blue Line: will give you the current GEX level (at the spot price). Thanks. This channel relies on limited liquidity of the underlying market, but it is distinct from information frictions (adverse selection and private information) and funding liquidity frictions (margin requirement shocks). Well, if we only anlayze the nature of the sign: yes it is simple (basically you have to know how Gamma behaves when you have a long or short position in an option); however, the most important question is not whether the signs make sense, but whether the assumption is correct; and in order for us to answer this, we need to look at the shape of the volatility smile/smirk of an index. These flows are non-discretionary (dealers have to hedge) and occur regardless of the available liquidity! Now, MM trading 101 in terms of risk management. In this scenario, delta-hedging flows move in the same direction as the market, potentially amplifying the price action. You will download a .dat file. Well, that depends on the available liquidity at the time. To further explore this and other open research topics, visit: Primitive Open Research Questions. why?? Put and call options are agreements between two parties on selling or buying assets for a specific price on a certain date. Frequently leaving the market perplexed and confused as to what just happened. I like to do it assuming a range of prices from -20% to +20% from the current spot price to have a full picture of the GEX profile plus minus 20% of current price level. And many times, rightfully so. Market Liquidity So, in this post I want to explain what is gamma exposure (GEX) using a simpler and more straightforward approach (step-by-step formulas, as well as a script that I have developed in Rstudio so that you can analyze, at any time, the current GEX level of any ticker - however, I must warn you that the approach I'll explain works better for indexes rather than single names; and the guilty for this is the Volatility Smile/Smirk but we'll come back to this later in this post. Are you sure you want to create this branch? Now, the fun part. So a probable way to time the volatility spike. I hope you like this post and please share it if you found it useful. Of course, gamma is just one of the market forces here, and its impact largely depends on several factors, such as: Time to Expiry When gamma is <0 the price distribution widens out substantially and we estimate a negative average daily return. We test our joint hypothesis using a large panel of equity options that we use to compute a proxy of stock-level gamma imbalance. However, an educated guess can help us approximate gamma exposure. The function then outputs estimated spot market maker SPX gamma exposure with an optional sensitivity table (example below). A closely monitored data point is where the gamma is zero known as the gamma flip. When market makers and traders trade options, they must hedge their risks by buying and selling the underlying security of the underlying security in a process called Delta Hedging.. It's better to normalize the MAD variances for GEX 67%, 95% and 99.7% intervals, use MAD then 1.46 to normalize. They are sellers when the market rallies and buyers when it drops, conveniently adding liquidity and reducing volatility. One example is dAMMOp. Market makers in products with gamma exposure, such as options and leveraged ETFs, are commonly net short these products. For example, at the end of this month a lot of Negative Gamma (basically due to a very big trade of JPM that is currently ATM) will be remove from the market and that will have, or I think we can expect, a positive impact in terms of volatility. Yes, the same -$19Bn that we calculated earlier in Excel! The strongest effect is visible in the S&P 500, because it is such a widely traded index. As the underlying moves, so does the delta-hedging requirement. As volatility rises, systematic/managed volatility funds tend to cut exposure, further adding to the selling pressure and provoking more negative gamma flows. The primary risk-management technique is delta-hedging, which is when option traders start messing about in the equity markets. Options gamma is one of the most significant structural flows within the equity markets. Here, though, we're peeling away any and every layer of complexity to the computation and revealing a simple ratio: The gamma of all call open interest to the gamma of all put open interest. Quarterly third Friday options also have an added benefit of $SPX futures expiring on the same date. That's why we have Price^2; you have to multiply the initial GEX formula by Price * 1% and divide it by $1. Gamma exposure is an estimate that can help you gauge future volatility and stock price variance. In the paper Automated Market Making and Loss-Versus-Rebalancing (preprint), the authors Milionis et al. If you want to have access to the code that generates all this analysis (and more), use the following link. By accepting all cookies, you agree to our use of cookies to deliver and maintain our services and site, improve the quality of Reddit, personalize Reddit content and advertising, and measure the effectiveness of advertising. Notice that both a call and covered call have positive slopes for all prices, therefore positive . If we also knew that some LP positions were using borrowed assets, this would imply opposite GEX for those positions and bring liquidations into the mix. By entering and using this website, you acknowledge that you have read and understand our Terms of Service, our Cookie Policy and our Privacy Policy. t-Statistic Theta Tracking Error Turnover Value at Risk VaR Variance Vega Volatility YTD Gamma Exposure Gamma exposure, sometimes referred to as dollar gamma, measures the second order price sensitivity of an option or portfolio to changes in the price of an underlying security. - A stock's Call Skew influences the "Skew Adjusted GEX" (SA-GEX), which changes to reflect estimated MM exposure.A positive Call Skew is common in stocks which have outsized speculative call buying. Therefore, during positive GEX conditions we can expect a positive (not strong) uptrend, a low volatility environment, and a contango in the term structure of the volatility. prove in. that LVR is equivalent to the profit earned by arbitrageurs, and the profit for arbitrageurs is profit that the LPs cannot capture! . It would be equivalent if the act of buying fire insurance impacted the probability of a house burning down. This exacerbates market moves and removes liquidity (frequently, when its needed the most). Mainly, at any moment with a priori known market volatility, the current price and LP GEX at that price determine LVR (or LVH). Comment: GEX printing 1.000.000.000 closing in on a trough next week or just shy of one , let see what mkts give us next week. After a handful of assumptions about the price process, the authors find that the, How can we think of this quantity? Due to its nature, gamma can exacerbate market moves (short gamma) or dampen them (long gamma). We value education, free information and sovereignty. . GEX can be positive or negative depending on the options flow at a given price. This is a very interesting insight Now you can measure the level of "strength" a MM has and how it can "influence" the price of the underlying asset (remember: we are not talking about market manipulation we are talking about how many securities the MMs need to buy or sell to be fully hedge.. but, sometimes that number is so big that, at the end, they affect the price - So: are you saying those mini rallies at the end of the day could be due to this?? Any meme stock has a bunch of investors buying calls which makes Market Makers negative those deltas and negative gamma. For more on TradFi MM GEX, see the GEX whitepaper. Now, MM trading 101 in terms of risk management. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. Thank you so much for taking the time to read this! A MM's business is not related to expeculation; is related to creating a market and earning a fee for that (they don't want to earn money assuming any directional risk). At least that way, well recognize when it happens, and well be prepared. This is what positive gamma does, adds liquidity and stabilizes the market). Gamma and Gamma Exposure (GEX) are becoming increasingly important forces in today's market, and have the potential to become one of the most important non-fundamental flows in equity markets. If were above the gamma flip, the volatility tends to be low, as the market has to swim against the current of the options flow. Our research emphasizes improved UX for DeFi. Open Interest Disclaimer: in this blog you will only see personal opinions about investing. I am using Squeeze Metricsto get the approximate gamma exposure that market-makers take against some particular stock. Back in my day as a market maker on the floor of the Chicago Board of Options Exchange (CBOE), the third Friday of the month was known as 'gamma day.' That was prior to 2005 when weekly options were introducedto show my age I was on the CBOE from 1991-2002and ever since 'gamma day, it has been a weekly occurrence.. Actually, with some Index and ETFs like SPY having expiration three . However, longer maturities tend to be listed on a quarterly (Mar/Jun/Sep/Dec) and yearly (Dec) basis only. We will be in touch. If we want to analyze the Gamma Exposure of the SP500 we have to calculate the Gamma Exposure for each strike (because each strike will have their own gamma) and for each expiration. This post compares DeFi LPs and TradFi MMs and connects the dots between LVR and GEX. No worries, the reason behind that square is the following: If Gamma * Open Interest * Multiplier * Spot price will give me the GEX for 1$ move change in price of the underlying asset (mainly because gamma is the change of delta per 1$ price move in the underlying asset); how much will it be the GEX if I have Price * 1% move?? For improved forecasting power, SpotGamma subscribers have access to the SpotGamma Implied Volatility (SIV) Index, a new and improved method to forecast market volatility, which you can learn . Hey there, I'm Kristian and I am an independent equity and derivatives trader with 6+ years of hands-on experience. Due to its nature, gamma can exacerbate market moves ("short gamma") or dampen them ("long gamma"). Your request has been submitted successfully. Well, there isnt much we can do apart from trying to understand how and when these options traders impact the equity markets. Can we quantify the GEX for DEXs that are combined with borrowing/lending protocols? The authors Angeris et al. At the moment, the $SPX options alone account for about 16% of the $SPX market cap. Proper active management would mitigate GEX. Go to http://www.cboe.com/delayedquote/quote-table-download and enter "SPX" in the ticker box. They do their best to flatten the risk with other options, but the residual exposure is hedged with underlying shares or futures a process known as delta hedging. Given that an LP experiences losses due to the inability to hedge GEX actively, it is of great interest to design LP positions that allow for active liquidity management. Now, imagine a scenario where an MM is long or short many different puts or calls of various strike prices and expirations. However, theres a key and vital difference. While a gamma squeeze pushes the price up, the market maker is hedging, so they are not theoretically losing money. However, during negative GEX conditions, we can expect violent price movement, possibly seeing lower lows (down trend) and a backwardation in the term structure of the volatility. And its the highest for short-dated, at-the-money (ATM) options: Hence, if the market is trading around a soon-to-expire strike with a high open interest, its more likely that its gamma flows will impact the market. And this number is the Delta Exposure in dollar terms for this trade. When someone wants to buy or sell an option, a Market Maker (MM) will must likely be at the other side of that transaction; meaning that: If you want to buy an option, a MM will sell that option to you. By understanding GEX and LVR, LPs can try to predict how to best manage their positions. The MM needs to invest 13.340 USD to be "fully hedge" at initiation. How can we think of this quantity? However, diversification isnt practical when hedging a book of $SPX options. The usefulness lies in the fact that the lower gamma exposure is the higher is the volatility of that particular stock price, since when gamma < 0 market-makers' actions amplify moves both up and down. Given the fact that it had already sold 29 shares, it only needs to sell 1 more share (spoiler: this means that because the MM is long gamma - because it is long an option - every time the price of the underlying goes up, it needs to sell shares of the underlying to hedge its position and every time the price of the underlying goes down, it needs to buy that underlying to hedge its position. A tag already exists with the provided branch name. Gamma Imbalance Heterogeneity in Use of Derivative Markets Figure 2. In the above equation, note that is the market volatility and that V(S) is precisely the of the LPs position. For some prices S, the curves may have larger curvature, which means the magnitude of is larger. Our research emphasizes improved UX for DeFi. The MM needs to sell 29 shares of SPY to be fully hedge (althoug, ironically, there is no such thing as fully hedge). A big factor in market movements is the market makers buying and selling options from and to the traders. Pick a point on one of the curves. I use Excel Pivot charts and Python to implement a great visual representation of gamma hedging. In contrast, the put has negative . As a result, they have to buy additional securities when prices are rising, and sell when prices are falling to help to ensure their positions are neutral even as the value of the underlying changes. Thus, by managing an LPs GEX, the LP can take back profit from arbitrageurs and keep it for themselves. By using the Black-Scholes formula (in the script that you can see in the following image), we can calculate all the greeks of that option. There is some ability to predict the movement and volatility of the market price given the MMs desire to remain -neutral. Learn more. Ever since our 2016 paper on gamma exposure (GEX), people have been eager to replicate and extend the concept. Dealer gamma exposure can be long or short (depending on options positioning in the market) with opposite effects amounting to billions of dollars of forced supply and demand: Long Gamma: dealers hedge by buying more with each point a security falls (and vice versa) and suppress volatility. seek to characterize Impermanent Loss (IL). SPX-Gamma-Exposure is a Python library typically used in Analytics applications. It is a matter of applying Itos lemma, as in the proof of Theorem 1 of the paper by Milionis et al., to see that this integral from the Monotonic Payoffs paper is LVR. We discuss how market designers, crypto traders, LPs and quants can build positions to reduce the GEX loss vector. As a trader, options allow for more fine-grained control over payoffs and can cap downside risk because options have nonlinear payoffs, unlike longs or shorts on the underlying asset. Since these maturities have been around for longer, they accumulate a considerable open interest. Calculates estimate of market maker gamma exposure derived from S&P 500 index options. Gamma can be calculated by simply knowing how much the delta of the option changed per 1$ price move of the underlying asset. Market makers (MMs) are market participants that get paid to add liquidity to markets. However, are these flows strong enough to move the market? Delta is an option's exposure to the underlying's moves. If an option position has high gamma, its delta will shift significantly when the underlying stock moves. The nonlinear payoff allows traders to make directional bets and hedge unfavorable price movements. Succinctly, if V(S) is the value of some position for price S, then =V and =V=. Gamma Exposure (GEX) One of the most important parts of trading the market is finding an edge in the market which is sort of reliable to trade constantly. Past performance is a poor indicator of future performance. Gamma exposure is the second order price sensitivity of a certain derivative to changes in the price of its underlying security. On an index level, it is generally believed that investors predominantly buy puts for protection and sell calls as part of overwriting strategies. I have read and accept our Terms and Conditions, Terms of Service and Privacy Policy. Follow me on Twitter (https://twitter.com/perfiliev) for more educational threads around stocks, options and other topics within the incredible world of financial markets. You should google Skew-Adjusted GEX, which makes adjustments to Naive GEX based on the current demand of calls relative to puts. When the street is long gamma, that means option market makers net-net bought options. Also, another way is by using the Black-Scholes formula (as shown in the previous images). More truthfully, they define a general measure of Loss-Versus-Rebalancing (LVR), which allows the LP to choose their own benchmark for portfolio balancing. The call and put both have positive , and the covered call has negative . Now, imagine a scenario where an MM is long or short many different puts or calls of various strike prices and expirations. They write options for meme stocks to hide fails to deliver, Let's Talk About: Whats the point of all of this? As a trader, options allow for more fine-grained control over payoffs and can cap downside risk because options have nonlinear payoffs, unlike. Click the link we sent to , or click here to sign in. Delta-hedging and unwinding these positions can increase market activity around the expiration time. YOU MAY NOT BE INTERESTED IN OPTIONS, BUT OPTIONS ARE INTERESTED IN YOU! You can download it from GitHub. A MM's business is not related to expeculation; is related to, So, the moment that person sold that option a MM bought it; and for the MM to be "free" of directional risk it needs to take the delta of that option, multiply it by the multiplier of the underlying (in this case it's 100 shares of SPY per option contract) to know how many shares of SPY needs to, Now the delta of this position is 0.30. They can help protect your portfolio when the sky is grey, and the rain washes down your hard-earned gains. The usefulness lies in the fact that the lower gamma exposure is the higher is the volatility of that particular stock price, since when gamma < 0 market-makers' actions amplify moves both up and down. So, for a MM to be "free" of any directional risk it has to hedge their position everytime someone wants to buy or sell an option.

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