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Understanding the S&P 500 Index (SPX) gamma exposure across the entire options chain is crucial for market participants to gain insight into dealer positioning and its potential impact on price discovery.
This article will guide you through the basic process of interpreting gamma exposure in terms of dealer positioning and its effect on the market due to hedging activities so that you may gain the most value possible from our SPX gamma profile charts.
We've also introduced a number of options-focused tools on our Discord server and an SPX Options Visualizer add-on for Bookmap and soon other charting software.
Net Gamma Exposure
Net gamma exposure is a measure of the overall market's sensitivity to changes in the price of the underlying asset (in this case, the S&P 500 Index). It is calculated by summing up the gamma values of all options in the options chain. Large net gamma exposure levels at key strikes can provide insights into dealer positioning and how it may impact price discovery due to hedging.
When we see a significant amount of net exposure at a close to the money strike, it often will have an impact on market price dynamics in several ways. If the level is above us, it may act as resistance. Below us and it may act as support. In some cases it may also act more like a magnet for price. Particularly when price is trending in that direction.
Dealer Positioning
Dealers who sell options are typically long gamma, meaning they have a positive net gamma exposure. This is because they must hedge their positions by buying or selling the underlying asset, thereby impacting price discovery.
Price Discovery Impact
When dealers hedge their long gamma positions, they buy the underlying asset as its price decreases and sell as the price increases. This dynamic can help stabilize market movements by mitigating the impact of large price swings.
However, if there is a significant change in the underlying asset's price, dealers may need to adjust their hedges more frequently, causing increased buying or selling pressure and impacting price discovery and promoting higher levels of realized volatility.
Individual Put and Call Gamma Exposure
Individual put and call gamma exposure represent the sensitivity of an option's price to changes in the underlying asset's price. By analyzing the gamma exposure of individual puts and calls, we can better understand how specific options may influence dealer positioning and price discovery.
Similar to the first chart, this chart also identifies key levels of gamma exposure, but it does so by breaking out puts and calls separately. Nevertheless, the outcome is similar. These levels of significant gamma exposure may act as support and resistance, and as price approaches they may also act like magnets, drawing price to them.
Put Gamma Exposure
Put options give the holder the right to sell an asset at a specific price. As the underlying asset's price decreases, put options become more valuable, and their gamma exposure increases. When dealers are short put options, they are exposed to negative gamma, which can create a hedging requirement that may exacerbate market downturns.
Call Gamma Exposure
Call options give the holder the right to buy an asset at a specific price. As the underlying asset's price increases, call options become more valuable, and their gamma exposure increases. When dealers are short call options, they are exposed to negative gamma, which can create a hedging requirement that may exacerbate market upturns.
Negative and Positive Gamma
Negative and positive gamma exposures provide insights into dealer positioning and the potential impact on market dynamics. Understanding the implications of these gamma exposures is essential for anticipating the effects of hedging activities on price discovery.
The above chart demonstrates where the gamma flip level is calculated and how much of an impact on dealer positioning it may have in billions of dollars.. Below the flip level and we are in negative gamma territory. Above it and we are in positive gamma territory.
Negative Gamma
When dealers have a negative gamma exposure, it means they are short options and must hedge their positions by trading the underlying asset in the opposite direction of the price movement. This dynamic, known as the "chase dynamic," can amplify price movements as dealers continuously adjust their hedges in response to market fluctuations. The chase dynamic associated with negative gamma can lead to increased realized volatility in the market.
Positive Gamma
Dealers with a positive gamma exposure are typically long options, which means they must hedge their positions by trading the underlying asset in the same direction as the price movement. This dynamic can suppress realized volatility as dealers buy the underlying asset when its price decreases and sell when the price increases, essentially dampening large price swings. Positive gamma exposure can contribute to a more stable market environment, which may be more conducive to orderly price discovery in the underlying index.
Closing thoughts
Interpreting SPX gamma exposure across the entire options chain is essential for understanding dealer positioning and the potential impact of hedging activities on price discovery. By knowing the gamma flip level and by analyzing net gamma exposure, as well as individual put and call gamma exposures, market participants can gain insights into the potential market dynamics and the role of dealers in influencing price discovery dynamics.
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