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I have a few burning questions for either you or beezle if either of you don't mind: 1) Are options market makers mostly long or short gamma, and does this ten

I have a few burning questions for either you or beezle if either of you don't mind: 1) Are options market makers mostly long or short gamma, and does this tendency differ if we're talking about puts versus calls? I know this can all vary over time, but I'm wondering if there's any systematic tendencies here, especially pertaining to index options. 2) Do you think gamma hedging drives a significant percent of volume in index futures (say 5% or more), or is it just a trivial %? 3) What would be a good way to estimate/approximate the gamma exposure of options market makers if we wanted to predict gamma squeezes, and we've only got public market data (e.g. trades and open interest)? SqueezeMetrics advocates using open interest but I'm wondering if there's a better way to do this. 4) Compared to delta & gamma hedging, do any of the other greeks (e.g. vanna) drive a significant percentage of volume in in the underlying in certain contexts, or are they mostly a side show?

lordnacho 6y ago
1) Good question. There's a tendency for implied vols to be higher than realised, so you'll tend to lose money holding options. This is a central element in Taleb's Black Swan stuff. The people he was talking about were people like me, and I actually met him in the office for a chat about options stuff once. Basically if you're incentivized to be short gamma, some traders will act on that and blow up now and again. 2) I think so, firms I worked for threw around a fair few index futures to hedge. quantifying it isn't too easy though. A lot depends on how close you are to the strike and the expiry. 3) You can't avoid looking at open interest, but I guess you can weight it by the gamma. 4) Vanna is a cross greek of vol and price. The other missing piece is interest rates, and from that you can imagine a zoo of greeks. But mainly it's the connection between vol and price that matters, there's a slidey thing you use to move the volatility surface when the price moves. I guess if I were you I'd scrape all the open interest info and see about the relative size of presumed gamma to liquidity in the market. It's a bit of an exercise.
- hntrader 6y ago
  Thanks, very informative stuff. (1) and (3): If we're to use open interest (along with the gamma of such open interest), it seems that we have to make specific assumptions about whether options' market makers are going to be net short/long, and by how much, in each specific contract, in order to perform the calculations. What such assumptions do you think that we should use for that, and I wonder if there's a way to make it more accurate than simply assuming "100% of this open interest in this specific put is held short by options market makers"? That seems to be the assumption made in [1], which is definitely very incorrect but maybe it's the best we can do? (4) So I guess flow that results from vanna hedging (and the other greeks aside from delta/gamma) is pretty small then. A number of people on Twitter make a big deal out of vanna hedging - they seem to think it can predict moves in the underlying, but they must be mistaken if not much flow comes from it as a result. [1] https://squeezemetrics.com/download/white_paper.pdf https://squeezemetrics.com/download/white_paper.pdf
  - lordnacho 6y ago
    I didn't mean to suggest that vanna isn't important, it's just part of the same mix of things to think about when prices/vols/rates move. Somehow it never came up much in conversation by that name, but it was a thing to think about. The squeezemetrics people seem to have quantified it, it's actually quite impressive. The GEX and VEX thing seems to be what you are alluding to, and they seem to have crunched the numbers. Browsing the papers it seems they assume that the customers are selling the calls and buying the puts? I think it makes sense, it's more sensible than saying all the open interest is one way on the market makers.
beezle 6y ago
3) I agree OI is going to be the goto but I'd caution to have a good feel for the underlying and market participants. It is not just market makers that sell calls - covered writes are a popular strategy by investors to pick up income. Vertical spreads are used by some punters too. Puts are where it is likely to be just market makers on the short side - lots of insurance buying but few nakeds or covered shorts.
- hntrader 6y ago
  Regarding calls, do you have suggestions on how to figure out if the OI in some particular call is mostly market makers' short or investors' short? I know you referenced "good feel for the underlying and market participants" in order to answer that question, but I'm wondering if there's a specific idea you could suggest regarding that to help narrow my focus? > It is not just market makers that sell calls Would you guess that market makers are, on average, net flat, net short, or net long calls?

lordnacho 6y ago

1) Good question. There's a tendency for implied vols to be higher than realised, so you'll tend to lose money holding options. This is a central element in Taleb's Black Swan stuff. The people he was talking about were people like me, and I actually met him in the office for a chat about options stuff once. Basically if you're incentivized to be short gamma, some traders will act on that and blow up now and again. 2) I think so, firms I worked for threw around a fair few index futures to hedge. quantifying it isn't too easy though. A lot depends on how close you are to the strike and the expiry. 3) You can't avoid looking at open interest, but I guess you can weight it by the gamma. 4) Vanna is a cross greek of vol and price. The other missing piece is interest rates, and from that you can imagine a zoo of greeks. But mainly it's the connection between vol and price that matters, there's a slidey thing you use to move the volatility surface when the price moves. I guess if I were you I'd scrape all the open interest info and see about the relative size of presumed gamma to liquidity in the market. It's a bit of an exercise.

hntrader 6y ago
Thanks, very informative stuff. (1) and (3): If we're to use open interest (along with the gamma of such open interest), it seems that we have to make specific assumptions about whether options' market makers are going to be net short/long, and by how much, in each specific contract, in order to perform the calculations. What such assumptions do you think that we should use for that, and I wonder if there's a way to make it more accurate than simply assuming "100% of this open interest in this specific put is held short by options market makers"? That seems to be the assumption made in [1], which is definitely very incorrect but maybe it's the best we can do? (4) So I guess flow that results from vanna hedging (and the other greeks aside from delta/gamma) is pretty small then. A number of people on Twitter make a big deal out of vanna hedging - they seem to think it can predict moves in the underlying, but they must be mistaken if not much flow comes from it as a result. [1] https://squeezemetrics.com/download/white_paper.pdf https://squeezemetrics.com/download/white_paper.pdf
- lordnacho 6y ago
  I didn't mean to suggest that vanna isn't important, it's just part of the same mix of things to think about when prices/vols/rates move. Somehow it never came up much in conversation by that name, but it was a thing to think about. The squeezemetrics people seem to have quantified it, it's actually quite impressive. The GEX and VEX thing seems to be what you are alluding to, and they seem to have crunched the numbers. Browsing the papers it seems they assume that the customers are selling the calls and buying the puts? I think it makes sense, it's more sensible than saying all the open interest is one way on the market makers.

beezle 6y ago

3) I agree OI is going to be the goto but I'd caution to have a good feel for the underlying and market participants. It is not just market makers that sell calls - covered writes are a popular strategy by investors to pick up income. Vertical spreads are used by some punters too. Puts are where it is likely to be just market makers on the short side - lots of insurance buying but few nakeds or covered shorts.

hntrader 6y ago
Regarding calls, do you have suggestions on how to figure out if the OI in some particular call is mostly market makers' short or investors' short? I know you referenced "good feel for the underlying and market participants" in order to answer that question, but I'm wondering if there's a specific idea you could suggest regarding that to help narrow my focus? > It is not just market makers that sell calls Would you guess that market makers are, on average, net flat, net short, or net long calls?